Supreme Court foreign tax credit case

As long as I am writing blog entries that mention Supreme Court litigation, perhaps I ought to mention the pending case of PPL Corporation v. Commissioner, which concerns foreign tax credits, and thus seemingly is right up my alley.  But there is also a reason why I hadn't addressed it previously.

This case concerns an episode from the U.K. some years ago involving the privatization of previously government-owned public utilities.  Back in the 1980s, the Thatcher government pushed through a privatization, opposed by the Labour minority in Parliament.  The process resulted in huge profits to the initial investors, as in retrospect the initial stock price turned out to be much too low given the profits that the newly privatized industry quickly started showing.  (This may conceivably have been because of unanticipatedly great efficiency gains once the industry was in private hands, but the opposing story is that it reflected overly lax regulation - clearly a relevant issue in the realm of public utilities, and I don't know what the real story was).

Anyway, Labour came back into power in the early 1990s, having emphasized in its winning campaign that, while it would let the privatization of the utilities stand, it would enact a special windfall tax on the companies, relating to the (at least ex post) underpricing in the privatization process.  The windfall tax was duly enacted, and it used a formula that applied a multiple of average annual financial accounting profits over a four-year period to determine "value in profit making terms) that would tend be compared to the issue price.

U.S. multinationals that ended up paying this tax claimed foreign tax credits (FTCs) under U.S. income tax law.  But the foreign tax credit rules allow credits only for "income, war profits, and excess profits" taxes, and applicable Treasury regulations provide that a foreign tax is creditable only if its "predominant character" is that of an income tax in the U.S. sense.  This in turn depends on such features as whether it is realization-based (so a Haig-Simons income tax might not be creditable!), whether it starts from something that is close enough to gross receipts, and whether it then provides sufficient deductibility to suggest that it is aimed at net income.

The Treasury denied foreign tax credits, seemingly based in part on the formalistic concern that the levy didn't facially purport to be an income or even an excess profits tax, hence it didn't matter what someone might argue it actually was.  The Treasury won in one circuit and lost in another, and the Supreme Court decided to grant certiorari - taking on its first foreign tax credit case in more than 70 years - even though the particular tax at issue in this case matters only as to a handful of taxpayers.  I gather there is some possibility that the main game being hunted by the Supreme Court here pertains to administrative law (regulations versus case law, agency interpretation of regulations, etc.), but nonetheless the case could generate a precedent or dicta with subsequently influence on broader issues of foreign tax creditability.

There have been two academic interventions in the proceeding.  A group of tax economists, with Rosanne Altshuler holding the at least alphabetically derived pride of place, filed an amicus brief in support of the cert grant.  They urge that the Supreme Court uphold the creditability of the U.K. windfall tax, on the ground that it is economically equivalent to a creditable income or excess profits tax.  After cert was granted, a group of tax law professors, headed by Michael Graetz, filed an amicus brief in support of the government's position.  They urge that the Treasury's position be upheld, even though they agree that the tax bears an economic resemblance to creditable income taxes, on grounds worth quoting because I believe they have a certain force (whether or not one adopts their bottom line position):

"[S]ince 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 ... 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 and subsequently imposing a retroactive levy to compensate for the previous undervaluation."

Here's the problem.  Both sides are right, at least as far as they go.  The economists are right that this is a lot like an income tax, merely stated differently; and that form over substance (the easiest way to get to the government's bottom line) is generally something that one shouldn't want to rely on; and that the rationale for foreign tax credits at least arguably is at issue here.

But Graetz et al are right that the foreign tax credit appears designed to apply to some taxes (i.e., income taxes and their ilk) and not others that appear to be economically equivalent, other than in dimensions that have no obvious link to the question of whether a foreign tax credit should be extended or not.  For example, why should expensing, which could turn what was otherwise an income tax into a VAT-like consumption tax, be relevant to creditability?  What's the coherent reason for crediting foreign taxes but not property taxes, when the value of property may simply be a multiple of annual earnings?

E.g., suppose you own a foreign perpetuity that earns $5 per year, and that thus is worth $100 since the relevant discount rate is 5 percent.  A 40 percent foreign income tax is pretty hard to tell apart, other than in how it's formally stated, from a 2% property tax.  You pay $2 a year forever either way.

My forthcoming international tax book addresses the issue only to this extent: I criticize the FTC, which is a provision that strikes me as making no sense other than in the case of a reciprocal deal between two peer countries.  I note that a tool as powerful as the FTC (which offers 100 percent reimbursement of foreign tax expenses) is bound in practice to be equipped with lots of lots of bells and whistles that limit taxpayers' ability to have fun with it.  I further note that one of these limitations is the requirement that it be an income tax, but comment that the rationale for this particular limitation is unclear.

There's a fairly small literature in which a few good writers have done their best to try to rationalize the income tax requirement for the FTC.  But since the limitation results in distinctive treatment of foreign taxes that, as an economic matter, are rather similar, they've understandably had a hard time of it.

If one were thinking of the foreign tax credit in a reciprocal framework - although the U.S. enacted it unilaterally, and has never conditioned it on the other country's crediting our income taxes - one might be inclined to say: The reciprocal deal that the Congress happened to have in mind (at least implicitly, in pursuit of what is often the useful myth of "legislative intent") was just about income taxes, and not about them plus equivalents or near-equivalents in different clothing.  So it's like interpreting a contract, in which the parties agreed about A but not B, and we enforce their agreement as intended even though we think A and B are pretty much the same.

One background fact that I suspect helps to explain the filing of the economists' brief is as follows. In the 1990s, Bolivia wanted to enact a corporate cash-flow tax, but decided to enact a corporate income tax instead because the IRS told the Bolivians that the option they preferred would not be creditable. Yet it is hard to think of any good reason why the U.S. should have wanted to steer the Bolivians towards the one alternative rather than the other, an outcome which is bad for them without being discernibly good for us.

I am inclined to line up on the Graetz / pro-government side, but this reflects that I don't like the foreign tax credit as a policy matter.  However, if I were a judge deciding the case, I would have to spend more time than I have on the technical legal issue, concerning proper interpretation of the applicable legal authorities as written.