Supreme Court Overturns U.K. Energy Windfall Tax Decision

On May 20, 2013, the U.S. Supreme Court ruled that a “windfall tax” imposed on a subsidiary of PPL Corporation (“PPL”) by the United Kingdom (“U.K.”) is creditable for U.S. tax purposes. The Supreme Court held that the predominant character of the tax was tantamount to an excessive profit tax, and therefore, is classified as an income tax and creditable for U.S. purposes. The Supreme Court’s ruling overturned the U.S. Court of Appeals for the Third Circuit’s (“Third Circuit”) prior decision on the matter.

In 1997, the U.K. imposed the one-time windfall tax on 32 U.K. companies that were privatized between 1984 and 1996. The 23% tax was applied to any additional profits that the companies earned beyond what the companies would have earned if they remained under government control. PPL indirectly owns 25% of one of those companies, South Western Electricity. Due to the windfall tax, PPL claimed a foreign tax credit on its 1997 U.S. federal income-tax return. While the Commissioner of Internal Revenue rejected the credit, on September 9, 2010, the U.S. Tax Court held that the windfall tax was creditable for U.S. tax purposes. On December 22, 2011, the Third Circuit reversed the Tax Court’s decision, finding that the tax was not creditable because it was a tax based on a valuation of the company, and not an income tax. PPL appealed the Third Circuit’s decision to the Supreme Court.

In its appeal, PPL noted that the Internal Revenue Code Section 901(b)(1) allows a credit for U.S tax purposes to any “income, war profits, and excess profits” that are paid to a foreign government. PPL argued that the substance of the windfall tax was equivalent to that of a U.S. income tax under Section 901(b)(1). According to PPL, any “tax based on profits above some threshold is an excess profits tax.”

The Supreme Court agreed. Justice Clarence Thomas, writing for a unanimous Supreme Court, held that the “predominant character of the windfall tax is an excess profits tax, a category of income tax in the U.S. sense.” In the analysis, Justice Thomas noted that for U.S. tax purposes, the classification is not determined on how the foreign government classifies the tax, but whether the tax in the U.S. would be classified as an income, war profits, or excessive profit tax. Justice Thomas concluded that regardless of the U.K.’s classification of the tax based on the difference of two values, the tax is nonetheless based on net income, and “[t]he economic substance of the windfall tax is that of U.S. income tax.”