February 25, 2013
[Note: Miller & Chevalier filed a brief in this case in support of PPL on behalf of American Electric Power Co.]
Seven Justices (all but Justices Thomas and Alito) asked questions in the oral argument in PPL on February 20, but they did not obviously coalesce around any particular view of the case. Even in cases where the questioning can be more neatly categorized, it is always hazardous to try to predict the outcome based on the questioning at oral argument. At this point, the parties’ work is done, and they are reduced to waiting for a decision, which is likely to come down in May or June — certainly no later than the end of June.
Former Solicitor General Paul Clement argued first on behalf of PPL. Justice Sotomayor began the questioning of Mr. Clement and asked him the most questions. She pressed him on why the tax could not be regarded as a tax on value. She also expressed “fear” over what she saw as the breadth of the taxpayer’s position, characterizing PPL as seeking a rule that a tax is creditable “anytime a tax uses estimates of profits.” Mr. Clement responded that this “emphatically” was not the taxpayer’s position, explaining that normal valuation is prospective and hence taxes that use future estimates for valuation will always fail the realization requirement for creditability. In response to Justice Sotomayor’s suggestion that using actual profits was a reasonable way to “find the original flotation value,” Mr. Clement responded that “you would never do that in any normal valuation” because “the first rule of thumb” for those kinds of historical valuations “is to avoid hindsight bias.”
Several other Justices also asked questions of Mr. Clement, focusing on different issues of interest to them. Justice Kennedy asked a series of questions exploring the significance of the tax being labeled as a tax on value, or reasonably viewed in part as “a tax on low value,” notwithstanding that it is also logically seen as a tax on profits. Mr. Clement responded that the substance of the tax is “exactly like a U.S. excess profits tax” but did not “look at a normal rubric of value” because “the only measure of value here is by looking at retrospective earnings over a 4-year period.” Justice Ginsburg asked whether there were other examples of taxes like the U.K. Windfall Tax. Justice Breyer asked a series of questions exploring the operation and rationale of the tax as it applied to companies that had not been in operation for the full four-year period in which historical profits were measured. Mr. Clement stated that even these companies did not pay an amount of tax that exceeded their profits and, moreover, that creditability is to be determined by the “normal circumstances in which it applies,” not by the outliers.
One perhaps surprising aspect of the argument was the attention paid to the amicus brief filed by a group of law professors. Justice Kagan’s extensive questioning of Mr. Clement focused on an argument introduced by that amicus brief – namely, that the tax should not be treated as an income tax because of the way it treats the “short-period” outliers by looking to their average profits, not total profits, in determining the amount of the taxable “windfall” received. Specifically, the tax rate on those few companies who did not operate for the entire four-year period was higher than for the vast majority of the companies. Mr. Clement noted that the reason for this was because the taxing authorities “were trying to capture the excess profits during a period in which there is a particular regulatory environment” conducive to excess profits; for the short-period taxpayers the way to do this was to “hit them with a reasonably tough tax in year one but year two, three, and four they were in a favorable regulatory environment and they get no tax at all.” (Justice Breyer later stated that, “because time periods vary, rates will vary, but I don’t know that that matters for an income tax.”) Mr. Clement also emphasized here, as he did later to Justice Breyer, that the outlier case does not control creditability, which is determined based on the normal circumstances in which the tax applies. The amicus brief was also mentioned briefly by Justice Sotomayor.
After Assistant to the Solicitor General Ann O’Connell took the podium, Chief Justice Roberts engaged her on the amicus brief as well, pointing out that the argument discussed by Justice Kagan was “not an argument that you’ve made.” When Ms. O’Connell agreed, but pointed to the amicus brief, the Chief Justice remarked that “I don’t think we should do a better job of getting money from people than the IRS does.” In response to Justice Sotomayor, Ms. O’Connell sought to clarify the government’s position by distinguishing between two different points made in the amicus brief. With respect to the “aspect of the amicus brief that says if it’s bad for one, it’s bad for all,” that is not the government’s position; the government agrees with PPL that outliers do not control credibility. But with respect to the argument of the amicus that Justice Kagan had discussed in connection with the outliers – namely, that “it taxes average profits, not total profits” – Ms. O’Connell maintained that she was not saying that the argument was wrong, only that the government’s “principal argument” was that the predominant character of the tax “is not an income tax because of the way that it applies to everybody else.” Justice Kagan took the opportunity to state that she believed the argument developed in the amicus that had formed the basis for her questioning was “the right argument.”
Apart from the amicus brief discussion, Ms. O’Connell was questioned by Justices Scalia and Breyer on whether true valuations are based on historical profits, rather than direct market evidence of value. She responded that this was a good way to determine the value of the companies at the time of flotation. In response to questioning from the Chief Justice about how to treat a tax laid on income, Ms. O’Connell stated that a tax just “based on last year’s income” would be an income tax regardless of its label, but if the income were multiplied by a price/earnings ratio, it would be a tax on value. The topic of deference also made a brief appearance, with Justice Breyer suggesting that deference might be owed to the experts at the Tax Court and Justice Ginsburg wondering whether deference was owed to the government’s interpretation of its own regulations. The Chief Justice responded to the latter point by remarking that there did not appear to be a major dispute about the meaning of the regulatory language and hence that sort of deference “does not seem to move the ball much.”
Justice Breyer chimed in with a detailed discussion of the mechanics of the tax, suggesting that this indicated that the “heart of the equation in determining this so-called present value is nothing other than taking average income over the four-year period.” Ms. O’Connell disagreed, and after considerable back-and-forth, Justice Breyer remarked that he had “said enough” and he would go back and study the transcript to decide who was right.
Towards the end of the argument, Justice Ginsburg asked whether the regulation could be changed “so it wouldn’t happen again” if the taxpayer prevailed. Ms. O’Connell said that perhaps it could be made “even more clear than it already is,” but Justice Breyer wondered why it should be changed to make American companies “in borderline cases have to pay tax on the same income twice.” Ms. O’Connell disputed that characterization, stating that the taxpayer did get a foreign tax credit for payments it made of the standard British income tax and it would still get a deduction for the U.K. Windfall Tax payments if the government prevailed. Ms. O’Connell closed her argument by stating that the tax was “written as a valuation formula, and it’s not just written that way, but that’s the substance of what it’s trying to do.”