The U.S. Supreme Court has agreed to consider whether a domestic taxpayer is entitled to a foreign tax credit based on its payment of a windfall tax to the U.K. government. The Court's decision to grant certiorari in PPL Corp is expected to resolve a split among the circuit courts of appeal.
Beginning in the mid-1980s, the U.K. privatized several utility companies by selling shares in the public market. Following privatization, costs were reduced, and these utility companies became enormously profitable as a result. The shareholders who initially purchased stock of the utility companies were therefore able to sell the shares at enormous profits. Upon seeing this, the U.K. government effectively concluded that the utility companies were privatized at too low of a price (i.e. the government did not get enough money for the shares). Accordingly, the government decided to impose a windfall profits tax. The windfall tax was a one-time 23 percent tax on the difference between each company's profit-making value and the price for which the U.K. government had sold it. Many U.S. taxpayers had acquired shares in these utility companies. Consequently, the question quickly became whether the windfall profits tax was a creditable tax for foreign tax credit purposes.
The taxpayer involved in PPL filed a refund claim seeking a foreign tax credit for windfall profits tax paid to the U.K. The IRS disallowed the refund and the taxpayer petitioned the Tax Court.
The Tax Court initially held that the taxpayer was entitled to a foreign tax credit on the ground that the tax was on profits making it essentially in the nature of an income tax. However, the IRS appealed, and the Third Circuit Court of Appeals concluded that the windfall profits tax was not a creditable foreign tax and reversed the Tax Court. Significantly, however, the Fifth Circuit Court of Appeals agreed with the Tax Court in a companion case (Entergy Corp.).
As previously mentioned, the Third Circuit and the Fifth Circuit reached opposite conclusions regarding the deductibility of the U.K. windfall profits tax. The Supreme Court opinion will resolve this judicial split between the Third and Fifth Circuits. Hopefully it will also provide some insight for future analysis of foreign tax credit issues. However, the U.K. windfall profits tax is very unique and therefore the opinion will likely be narrow and specific to the nature and characteristics of the U.K. windfall profits tax. With that being said, I would not expect on too much insight beyond what we already have in terms of foreign tax credit analysis as a practical matter.