Supreme Court Asked to Resolve Circuit Split on Foreign Tax Creditability of U.K. Windfall Tax

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August 1, 2012

[Note:  Miller & Chevalier filed an amicus brief on behalf of American Electric Power in the PPL case.]

We have fallen behind in updating the progress of the litigation concerning the creditability of the U.K. Windfall Tax that was imposed on British utilities in the 1990s.  As we previously reported, the Tax Court held in two companion cases that this tax was equivalent to an income tax in the U.S. sense of the term and hence creditable.  The government took two appeals — to the Third Circuit in PPL and to the Fifth Circuit in Entergy.  Those courts reached opposite conclusions, and PPL has now asked the Supreme Court to grant certiorari to resolve the conflict.  (See here and here for previous posts on the parties’ briefing in these cases.)

The Third Circuit was first to rule, in December 2011, and it rejected the Tax Court’s decision in an opinion that rested in large part on arguments not made in the government’s brief.  The Third Circuit focused heavily on the details of the three-part test set forth in the regulations, stating that, in focusing on the “predominant character” language in those regulations, the Tax Court had errroneously suggested that the regulation “appl[y] a ‘predominant character standard’ independent of the three requirements.”  In that connection, the Third Circuit dismissed the relevance of case law that predated those regulations, notwithstanding language in the preamble indicating that Treasury did not intend to depart from that prior case law.  The Third Circuit also criticized PPL’s position that the “flotation value” component of the calculation was not relevant to the three-part test because it merely defined what part of the company’s profits would be taxed as “excess.”  The Third Circuit did not deny that this approach would appear to prevent any “excess profits” tax from meeting the test, but it explained that “this argument merely suggests that the regulation misinterprets the statute,” and it was too late for PPL to argue that the regulation is invalid.  Finally, the court surprisingly held that the Tax Court’s decision could not be squared with Treas. Reg. § 1.901-2(b)(3)(ii), Ex. 3, an example that illustrates how the gross receipts part of the regulatory test applies in a situation where the tax base is derived indirectly from a quantity that is “deemed” to reflect gross receipts.  This example is of dubious relevance to the Windfall Tax, which was based on actual profits, not a “deemed” quantity; the example was not raised in the Tax Court proceedings and was mentioned only tangentially in the government’s brief.

The Fifth Circuit had heard oral argument in Entergy a couple of months before PPL was decided, but did not issue its opinion until June 2012.  The Fifth Circuit stated that “the Commissioner’s assertion that we should rely exclusively, or even chiefly, on the text of the Windfall Tax” was contrary to settled case law establishing that the form of the foreign tax is not determinative.  “Viewed in practical terms,” the court continued, “the Windfall Tax clearly satisfies the realization and net income requirements.”  With respect to the gross receipts part of the test, the Fifth Circuit was “persuaded by the Tax Court’s astute observations as to the Windfall Tax’s predominant character” – namely, to claw back the utilities’ excess profits.

The Fifth Circuit then addressed itself directly to the Third Circuit’s PPL decision, characterizing the latter court’s reasoning as exemplifying “the form-over-substance methodology that the governing regulation and case law eschew.”  The example in the regulations relied upon by the Third Circuit is “facially irrelevant,” the Fifth Circuit observed, because “[t]he Windfall Tax relies on no Example 3-type imputed amount, nor indeed on any imputation, for calculating gross receipts.”  Thus, although noting that it is “always chary to create a circuit split,” the Fifth Circuit concluded that it had to disagree with the Third Circuit and find the Windfall Tax creditable.

After its petition for rehearing en banc was denied, PPL filed a petition for certiorari on July 9.  The petition emphasizes the need to resolve the circuit conflict in order to achieve uniform administration of the tax law and heavily criticizes the Third Circuit for elevating the form of the tax over its substance.  For its part, the government has chosen not to seek rehearing in Entergy, bringing the schedules of the cases closer together again.  A petition for certiorari in Entergy is now due on September 4.  The government’s response to PPL’s cert petition is currently due August 8, but a 30-day extension is likely, which would make the response due on September 7.

The position that the government decides to take in these cases is an important factor in assessing the prospects for a grant of certiorari.  Most federal tax cases heard by the Supreme Court involve clear conflicts in the circuits, and it is impossible to deny the existence of such a conflict here.  But the Court does not hear every tax case that involves a circuit conflict.  Rather, it agrees to hear a case only when it believes that resolution of the conflict is sufficiently important, particularly to the uniform administration of the tax laws. Historically, the Court has afforded considerable deference to the government’s advice on the question of importance.  As a repeat litigant at the Court, the government is very selective in asking for Supreme Court review, on the theory that if it does not ask too often, the Court is more likely to grant its requests when it really matters.  And the Court does grant a high percentage (in the neighborhood of 70%) of the government’s petitions for certiorari.  Thus, in deciding whether to ask the Court to resolve this conflict, the government will weigh its own interests, including estimating its prospects for success if the Court hears the case, and make a judgment about whether it views this issue as important enough to tax administration or to the government’s bottom line to justify using one of its precious “chits.”

Although one might think that the government’s monetary interests could induce it to oppose certiorari in PPL even if were to file a cert petition in Entergy, the Solicitor General’s long-term interest in maintaining credibility with the Supreme Court would trump those short-term monetary interests.  Thus, there are two likely courses of action open to the government.  Either it will oppose PPL’s petition and not push for Supreme Court review in Entergy or it will file a certiorari petition in Entergy and not oppose PPL’s petition.  Unless there are additional extensions, we should know in early September how the government will approach the conflict.  The Supreme Court will give its answer several weeks after that.

PPL Third Circuit opinion

Entergy Fifth Circuit Decision

PPL Petition for Certiorari

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