Sunday, January 27, 2013
Whether, in determining the creditability of a foreign tax, courts should employ a formalistic approach that looks solely at the form of the foreign tax statute and ignores how the tax actually operates, or should employ a substance-based approach that considers factors such as the practical operation and intended effect of the foreign tax.
The Third Circuit's opinion is here. For a detailed discussion of the case, see Jacob Goldin (Ph.D. Candidate (Economics), Princeton University), Reconsidering Substance Over Form in PPL, 137 Tax Notes 1229 (Dec. 17, 2012).
Tax Profs Anne Alstott (Yale), Marvin Chirelstein (Columbia), Mihir Desai (Harvard), Michael Graetz (Columbia), Daniel Halperin (Harvard), Mitchell Kane (NYU), Lawrence Lokken (Florida), Robert Peroni (Texas), and Alvin Warren (Harvard) have filed an amicus brief in support of the IRS. Here is the summary of their argument:
In 1997 the newly elected Labour government of the United Kingdom enacted a Windfall Tax applicable to a relatively small group of privatized regulated utilities that years earlier had been sold to the public at a fixed price (£2.40 a share for the regulated electric companies). For the initial four or five years following privatization, the previous Conservative government had also fixed the prices that these monopolies could charge their customers. The Windfall Tax was designed to redress both undervaluation at privatization (which for petitioners occurred in 1990) and subsequent lax regulation that permitted the utilities to charge unduly high prices during the initial period after privatization. The tax imposed is 23% of the difference between a recomputed share value (based on a fixed price-earnings multiple of earnings) and the lower value at which the shares were actually issued to the public at privatization (the “flotation value”).
Based on a specific mathematical reformulation of the tax, which more than doubles its rate and ignores or obscures important variables, petitioner claims that the UK levy is an “income or excess profits tax” eligible for dollar-for-dollar reimbursement by U.S. taxpayers under the foreign tax credit of § 901 of the Internal Revenue Code. But since the value of an income-producing asset necessarily depends on its earnings, a tax on value can be restated mathematically as if it were an income tax. The idiosyncratic algebraic reformulation on which petitioner rests its entire case is only one of several equivalent mathematical reformulations, a number of which lead to the opposite conclusion that the UK tax at issue here is not a creditable income tax. Petitioner would, in effect, have this Court extend the foreign tax credit well beyond its statutory scope of income and excess profits taxes to a whole host of taxes on value and perhaps even to consumption taxes, none of which have ever been creditable.
Precisely because petitioner’s reformulation would open the door to claims of foreign tax credits for foreign levies based on value, not income, if this Court accepts petitioner’s argument, it would provide a road map to foreign governments, encouraging them to shift the costs of privatization to U.S. taxpayers by initially undervaluing public assets and companies sold to private interests and subsequently imposing a retroactive levy to compensate for the previous undervaluation.
Under petitioner’s approach, U.S. taxpayers would reimburse a U.S. parent company dollar-fordollar for such retroactive payments made by its foreign subsidiaries. The UK tax at issue here is not an income or excess profits tax, and no foreign tax credit should be allowed for it under § 901.