I’ve recently blogged about the plethora of multi-jurisdictional tax issues which continue to increase as business becomes ever more globalized. On February 20th, the U.S. Supreme Court yesterday heard oral argument in PPL Corp. v. Commissioner. In PPL, the Court is considering:

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.

Unlike most other countries, the United States taxes corporate profits globally, not just U.S. source profits. In order to avoid double taxation, however, the U.S. also allows those corporations to write off most forms of foreign income taxes. A corporation may take advantage of the foreign tax credits if the foreign tax in question is “creditable.” According to the Internal Revenue Code, a foreign tax is creditable if it taxes “any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country.”

The Treasury Regulations further state that a foreign levy is an income tax if and only if:

(i) It is a tax; and

(ii) The predominant character of that tax is that of an income tax in the U.S. sense.

In this case, the U.K. imposed a one-time windfall profit tax. Arguing for the IRS, Assistant Solicitor General Ann O’Connell said that the UK windfall tax is “not an income tax, in the U.S. sense, and it should not be entitled to a credit.” The windfall tax, the IRS argues, was a mechanism to retroactively increase the price of the companies as of the time they were privatized and sold to PPL. Moreover, because the U.K. tax did not meet the realization, gross receipts, or net income requirements, the IRS argued that the windfall tax failed the predominant character test under the Treasury Regulations. In other words, was a tax on the increase in the corporation’s value, not on the corporation’s income and thus was not creditable.

PPL, on the other hand, argues that the “windfall” tax was actually and substantively a retroactive tax on income earned by the company over a roughly four-year period. Paul Clement, one of PPL’s attorneys, urged the court “look at the tax in its main applications,” instead of the form. Clement continued, “it’s the substance of the tax, not its purpose behind it that matters.,” therefore the Court should look at the substance over the form of the tax, an argument usually put forth by tax agencies.

The Courts decision is expected later this term.

The transcript of the oral argument is here. Click here to read the case briefs, petitions and lower court decisions.