May 30, 2013
The Court this week denied the government’s petition for certiorari in the Entergy case. As explained in our prior post on the PPL decision, this ruling was inevitable in the wake of the Court’s decision for the taxpayer in PPL. The denial of certiorari now cements Entergy’s victory in the Fifth Circuit.
The Court also denied certiorari in Historic Boardwalk, the historic rehabilitation tax credit case decided in the government’s favor by the Third Circuit. See our previous reports here.
May 20, 2013
[Note: Miller & Chevalier filed a brief in this case in support of PPL on behalf of American Electric Power Co.]
The Supreme Court this morning unanimously ruled in favor of PPL in its case involving the creditability of the U.K. Windfall tax. See our prior coverage here. The opinion was authored by Justice Thomas, with Justice Sotomayor adding a separate concurring opinion.
The Court’s opinion is fairly succinct. Viewing the government’s position as more formalistic, the Court stated that it would “apply the predominant character test [of the foreign tax credit regulations] using a commonsense approach that considers the substantive effect of the tax.” The Court stated that the regulatory test looks to “the normal manner is which a tax applies,” and “the way a foreign government characterizes its tax is not dispositive with respect to the U.S. creditability analysis.”
Applying this approach, the Court held that “the predominant character of the windfall tax is that of an excess profits tax,” which makes it creditable. By contrast, the Court found that the government’s attempt to characterize the tax as being imposed on the difference between two values was unrealistic, noting that the U.K. statute’s “conception of ‘profit-making value’ as a backward-looking analysis of historic profits is not a recognized valuation method,” but instead “is a fictitious value.” The Court agreed with PPL’s argument that the equivalency of the tax with a more typical excess profits tax could be demonstrated through an algebraic reformulation of the formula for computing the tax. The Court addressed this point in some detail, putting this opinion near or at the top of the rankings in the category of most algebraic formulas found in a single Supreme Court opinion. Declaring that it must look at “economic realities, not legal abstractions,” the Court concluded that it must “follow substance over form and recognize that the windfall tax is nothing more than a tax on actual profits above a threshold.”
Justice Sotomayor’s separate concurring opinion focused on an issue that featured prominently in the oral argument (see our report here) — namely, how the analysis is affected by the way the tax applied to a few “outlier” taxpayers who did not operate for the full four-year period governed by the tax. Echoing the position taken in an amicus brief filed by a group of law school professors, Justice Sotomayor stated that the treatment of these outliers indicated that “the windfall tax is really a tax on average profits” and ought to be viewed as a tax on a company’s value, not net income. Justice Sotomayor acknowledged, however, that her position “cannot get off the ground” unless the Tax Court was wrong in stating in Exxon Corp. v. Commissioner, 113 T.C. 338, 352 (1999), that “a tax only needs to be an income tax for ‘a substantial number of taxpayers’ and does not have to ‘satisfy the predominant character test in its application to all taxpayers.'” Since the government indicated at oral argument that it did not disagree with the Tax Court on that point, Justice Sotomayor concluded that she should not base her analysis of the case on her “outlier” argument and instead would join the Court’s opinion. Interestingly, Justice Kagan did not join the concurrence even though she was the Justice who appeared at the oral argument to advocate most strongly for the “outlier argument” made in the amicus brief.
For its part, the majority briefly noted this argument in a footnote at the end of its opinion, and stated that it would “express no view on its merits” since the government had not preserved the argument. Notwithstanding that disclaimer, the body of the Court’s opinion provides ammunition for persons who might wish to oppose Justice Sotomayor’s position in future cases. The Court stated that the predominant character test means that “a foreign tax that operates as an income, war profits, or excess profits tax in most instances is creditable, even if it may affect a handful of taxpayers differently.” Another item in the opinion that could find its way into briefs in future foreign tax credit cases is the Court’s observation that the 1983 regulation at issue “codifies longstanding doctrine dating back to Biddle v. Commissioner, 302 U.S. 573, 578-79 (1938).” In its court of appeals briefing in PPL, the government had denigrated the relevance of pre-regulation case law, stating that the regulations merely “incorporate certain general standards from those cases,” and arguing that PPL “cannot rely on pre-regulation case law—to the exclusion of the specific regulatory test—to make its case.” The Court’s opinion will lend support to litigants who want to rely on pre-regulation case law in future foreign tax credit cases.
The Court’s opinion in PPL effectively resolves the Entergy case as well. As we have reported, the government filed a protective petition for certiorari in Entergy, but it has never suggested that PPL and Entergy should be decided differently. Thus, in the near future, probably next Tuesday, the Court can be expected to issue an order denying that certiorari petition and thereby finalizing Entergy’s victory in the Fifth Circuit.
May 10, 2013
We previously reported on the Court’s grant of certiorari in Woods, noting that the government’s opening brief would be due on May 9. If you are looking for the brief, be advised that the Court has extended the filing date until May 30. The taxpayer’s brief will be due July 22.
May 9, 2013
The government has filed its brief opposing certiorari in Historic Boardwalk. The government characterizes the decision as resting “on a fact-bound examination of the agreements between the parties” that presents no legal issue of broad applicability warranting Supreme Court review. The brief responds at length to the taxpayer’s argument that the court of appeals misapplied Commissioner v. Culbertson, 337 U.S. 733 (1949), maintaining instead that “the court of appeals properly applied the framework set forth in Culbertson.”
As we previously noted, the taxpayer faces an uphill battle because the Court rarely hears technical tax cases over the government’s opposition in the absence of a circuit conflict. The Court is expected to act on the petition on May 28.
May 7, 2013
As a follow-up to our posts on the Goosen case regarding sourcing of a golfer’s income from sponsors (see here), we provide this update on the case involving golfer Sergio Garcia. While they were not technically related cases, the significant overlap in issues and facts—not to mention witness testimony—meant that the outcome in Goosen partially determined the outcome in Garcia.
Both cases involved the character of the golfers’ endorsement income. Coincidentally, the golfers each had an endorsement contract with the same brand—TaylorMade. The golfers both argued that the lion’s share of the endorsement income was royalty income (i.e., paid for the use of the golfer’s name and likeness) and not personal services income (which is typically subject to a higher tax rate than royalties because of tax treaties).
Garcia had sold the rights to his image to a Swiss corporation (of which Garcia owned 99.5%) that in turn assigned the rights to a Delaware LLC (of which Garcia owned 99.8%). Garcia’s amended endorsement agreement assigned 85% of the contract payments to the LLC as payments for the use of his image rights. So Garcia argued that at least 85% of the endorsement payments were royalty income by virtue of the terms of the endorsement agreement. The Service originally argued that none of endorsement payments were royalty income and that all of the payments were for personal services. But the Service later tempered its position and argued that the “vast majority” of payments were for personal services.
Thanks to some testimony by the TaylorMade CEO that undermined the allocation in the agreement, the Tax Court declined to follow the 85/15 allocation in the amended endorsement agreement. But the Tax Court also rejected the Service’s argument that the “vast majority” of payments were for personal services. And the Tax Court determined that a 50/50 split was unwarranted.
In rejecting the 50/50 split, the Court tied the outcome in Garcia directly to the outcome in Goosen. As we wrote before, the Court opted for a 50/50 split between royalties and personal services for Goosen’s endorsement income. But expert testimony in Goosen contrasted Goosen’s endorsement income with Garcia’s. The expert in Goosen (Jim Baugh, formerly of Wilson Sporting Goods) had testified that, while Goosen had better on-course results than Garcia, Garcia had a bigger endorsement deal because of Garcia’s “flash, looks and maverick personality.” Consequently, the Court found that Garcia’s endorsement agreement “was more heavily weighted toward image rights than Mr. Goosen’s” and decided on a royalty/personal services split of 65/35.
The Tax Court also rejected the Service’s argument that Garcia’s royalty income was taxable in the U.S. under the U.S.-Swiss treaty. Perhaps the IRS will appeal that legal issue. Will Garcia appeal? The Tax Court’s decision is a victory for Garcia relative to the outcome in Goosen. On the other hand, if Garcia’s brand hinges on his “maverick personality,” then perhaps the “maverick” thing to do is to roll the dice with an appeal. Decision has not yet been entered under Rule 155, so we will wait to see whether there is an appeal.
May 3, 2013
The Chief Justice has granted the government a second extension of time to file its petition for certiorari in Quality Stores. See our previous coverage here. The petition is now due May 31. By statute, the time to petition for certiorari can be extended for a maximum of 60 days, so the government is now about at the end of its rope, and it will surely fish or cut bait by the current May 31 deadline.