Foreign Tax Credits

Foreign Tax Credits

September 01, 2012

Foreign tax credits may soon be at issue in a case before the US Supreme Court.

PPL Corporation, the parent company of a Pennsylvania utility, asked the court in August to hear an appeal of whether the utility could claim windfall profits taxes it paid in the United Kingdom, after buying a privatized regional electric utility, as a credit against its income tax liability in the United States. The US allows foreign taxes to be credited, but only if they are income taxes in a US sense. The IRS has argued that the taxes are not creditable based on a reading of the UK statute. The IRS won on appeal in its dispute over the taxes with PPL Corporation, but lost in a similar case involving US utility Entergy, which had to pay windfall profits taxes on its shareholding in London Electricity. Both taxpayers won in the US Tax Court, but the cases were appealed to appeals courts in different parts of the United States based on where the taxpayers are located.

PPL argues that the IRS should look at the underlying substance of the UK tax rather than focus narrowly on the words in the UK windfall profits tax statute.

The British government collected a one-time tax on the “windfall profits” that the owners of the privatized utilities earned due to the initial bump up in share prices after privatization. The tax had to be paid in two installments in 1997 and 1998. The tax was 23% of the appreciation in value of each utility since privatization. The appreciation was calculated by comparing the amount paid for the shares at privatization to the company’s “value . . . in profit making terms” in 1997. This was defined as nine times the company’s average annual after-tax profits in the four years immediately following privatization.

Only “income taxes” may be credited. The IRS argues that the UK windfall profit tax fails because it was a tax on hypothetical appreciation in value of the regional utilities — rather than on actual gains — and the British government did not wait to collect the levy until the shareholders “realized” their gains by selling shares.

Keth Martin