IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 10-60988

ENTERGY CORPORATION AND

AFFILIATED SUBSIDIARIES,

Petitioner - Appellee

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent - Appellant

Appeal from a Decision of the

United States Tax Court

Before JONES, Chief Judge, and DAVIS and DeMOSS, Circuit Judges.

EDITH H. JONES, Chief Judge:

Appellant Commissioner of Internal Revenue (“Commissioner”) seeks

review of a United States Tax Court decision favoring Appellee Entergy Corp.

(“Entergy”) for the taxable years 1997 and 1998. By reference to a companion

case, PPL Corp. v. Comm’r, 135 T.C. 304 (2010), rev’d, 665 F.3d 60 (3d Cir. 2011),

the Tax Court concluded Entergy was entitled to a foreign income tax credit for

its subsidiary’s payment of the United Kingdom’s Windfall Tax. The sole

question on appeal is whether the Windfall Tax constitutes a creditable foreign

income tax under I.R.C. § 901, 26 U.S.C. § 901. Notwithstanding the Third

Circuit’s contrary opinion, we AFFIRM.

United States Court of Appeals

Fifth Circuit

F I L E D

June 5, 2012

Lyle W. Cayce

Clerk

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BACKGROUND

The Tax Court and parties treat PPL Corp. as materially identical to this

case; we do so as well. See Entergy Corp. v. Comm’r, 100 T.C.M. (CCH) 202

(2010). The Tax Court and Third Circuit ably detail the history of the Windfall

Tax, and we briefly summarize the relevant facts.

Entergy owns London Electricity, one of thirty-two companies, generally

utilities, the U.K. privatized through the 1980s and 1990s. The U.K.

government set price controls on these utilities but not caps on profits; the newly

privatized corporations quickly reduced costs beyond governmental expectations,

reaping higher-than-expected profits, share prices, and executive compensation. 

This in turn led to a public backlash.

In response, the then-opposition Labour Party proposed a new tax on the

utilities — a “windfall levy on the excess profits of the privatised utilities.” 

Enlisting the accounting firm Arthur Andersen, the Labour Party designed a

series of proposals, including gross receipts taxes and profits taxes, to recoup a

desired proportion of the utilities’ profits. Geoffrey Robinson, a Labour Member

of Parliament, and Gordon Brown, Shadow Chancellor of the Exchequer,

ultimately selected the Windfall Tax. Once in power, the Labour Party passed

the tax.

The Windfall Tax was designed to address the public’s concern that the

utilities had been sold too cheaply in light of their profit potential. It imposed

on each of the utilities a one-time 23% assessment on the difference between: 

(1) a company’s “profit-making value,” defined as its average annual profit per

day over an initial period (typically, as here, four years) multiplied by 9, an

imputed “price-to-earnings ratio,” and (2) its “flotation value,” or the price for

which it was privatized.

London Electricity timely paid slightly less than £140M as a result of the

Windfall Tax, and Entergy filed an amended US. federal tax return in 1998

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claiming an equivalent credit — approximately $234M. When the IRS

disallowed the credit in a notice of deficiency, Entergy contested the notice by

filing a petition with the Tax Court. Entergy and the Commissioner essentially

disagreed on whether the Windfall Tax — on “profit-making value,” calculated

as explained above — constituted a tax on excess profits, creditable under I.R.C.

§ 901, or a tax on unrealized value for which Entergy could not claim a foreign

income tax credit. Entergy demonstrated that the Windfall Tax could be

mathematically re-expressed as a pure tax on profits; the Commissioner pointed

to the statute’s reference to “profit-making value” as conclusively demonstrating

that the tax reached unrealized value rather than excess profits.

The Tax Court relied on its parallel decision in PPL Corp. v. Comm’r,

135 T.C. 304 (2010), applying the relevant Treasury regulation interpreting

Section 901, 26 C.F.R. § 1.901-2(a). Entergy, 100 T.C.M. (CCH) 202. The Tax

Court determined the Windfall Tax was based on excess profits, and that it

therefore necessarily satisfied § 1.901-2(a)’s three-part “predominant character”

test: namely, that the Windfall Tax (1) reached only realized income, (2) was

imposed on the basis of gross receipts, and (3) targeted only net income. PPL,

135 T.C. at 337-39. The Tax Court therefore ruled Entergy entitled to a tax

credit. Entergy, 100 T.C.M. 202. The Commissioner appealed in both PPL and

this case.

STANDARD OF REVIEW

This court applies the same standard of review to decisions of the Tax

Court as we do to district court decisions: findings of fact are reviewed for clear

error and issues of law are reviewed de novo. Terrell v. Comm’r, 625 F.3d 254,

258 (5th Cir. 2010).

DISCUSSION

The parties agree that 26 C.F.R. § 1.901-2(a) controls. It provides that “[a]

foreign levy is an income tax if and only if[] . . . [t]he predominant character of

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that tax is an income tax in the U.S. sense.” 26 C.F.R. §§ 1.901-2(a)(1), (a)(1)(ii). 

A foreign tax’s predominant character “that tax is that of an income tax in the

U.S. sense” if it “is likely to reach net gain in the normal circumstances in which

it applies.” Id. at §§ (a)(3), (a)(3)(i). “A foreign tax is likely to reach net gain in

the normal circumstances in which it applies if and only if the tax, judged on the

basis of its predominant character, satisfies each of the realization, gross

receipts, and net income requirements” established by the regulation. Id. at §

1.901-2(b)(1). 

The realization requirement tracks the American income tax principle that

income is typically taxed only following a “realization event,” usually “when

property is sold or exchanged.” BORIS I.BITTKER &LAWRENCE LOKKEN,FEDERAL

TAXATION OF INCOME, ESTATES & GIFTS ¶ 72.4.3 (2011). The gross income

requirement mandates that “[g]enerally, the starting point for calculating

income subject to a creditable foreign income tax must be actual gross receipts.” 

Id. And the net income requirement only allows accreditation for taxes which

“provid[e] for ‘recovery of the significant costs and expenses (including

significant capital expenditures) attributable, under reasonable principles, to

[the] gross receipts included in the tax base.’” Id.

The Tax Court considered two competing interpretations of the Windfall

Tax’s reliance on “profit-making value.” The Commissioner offered a “text-bound

approach to determining” creditability, relying primarily on the fact that the

Windfall Tax by its own terms levied the difference between two statutory

values. PPL Corp., 135 T.C. at 332, 334. The Commissioner further argued this

ineluctable conclusion flowed directly from theTax Court’s obligation to examine

the text of the Windfall Tax alone, to the exclusion of historical and

mathematical sources. Id. at 333. PPL, by contrast, argued that both

parliamentary history surrounding the Windfall Tax as well as algebraic

reformulations demonstrated that the Windfall Tax was both intended as and

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actually acted as an excess profits tax. Id. at 326-27. 

The Tax Court agreed with the latter view, refusing the Commissioner’s

argument that “the words of the . . . statute are the ‘substance’” of the tax and

affirming the propriety of resorting to extra-statutory sources under the

predominant character standard. Id. at 331, 334-35. The Tax Court concluded

that the Windfall Tax acted as an excess profits tax despite its imposition on

“profit-making value,” specifically noting that:

The architects and drafters of the tax knew (1) exactly which

companies the tax would target, (2) the publicly reported after-tax

financial profits of those companies, which were a crucial component

of the tax base, AND (3) [the ta]rget amount of revenue the tax

would raise. [T]herefore, it cannot have been an unintentional or

fortuitous result that, (1) for 29 of the 31 windfall tax companies

that paid tax, the effective rate of tax on deemed annual excess

profits was at or near 51.7 percent, and (2) for none of the 31

companies did the tax exceed initial total period gains. What

respondent refers to as “petitioner’s algebraic reformulations of the

Windfall Tax statute” do not, as respondent argues, constitute an

impermissible “hypothetical rewrite of the Windfall Tax statute[.]”[]

Rather, they represent a legitimate means of demonstrating that

Parliament did, in fact, enact a tax that operated as an excess

profits tax for the vast majority of the windfall tax companies. The

design of the windfall tax formula made certain that the tax would,

in fact, operate as an excess profits tax for the vast majority of

companies subject to it.

Id. at 339-341. The Tax Court concluded the Windfall Tax, a tax on excess

profits, satisfied each of the net gain test’s three requirements, and that it was

therefore a creditable foreign income tax.

The Commissioner reiterates his insistence on the primacy of the Windfall

Tax’s text, which uses the term “profit-making value” to describe the base for

calculation of the tax. This argument is easy to dispatch. The case law from

which 26 C.F.R. § 1.901-2 is derived refutes the Commissioner’s assertion that

we should rely exclusively, or even chiefly, on the text of the Windfall Tax in

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determining the tax’s “predominant character.” “The label and form of [a]

foreign tax is not determinative.” Inland Steel Co. v. U.S., 677 F.2d 72, 80 (Ct.

Cl. 1982). “We do not . . . consider it alldecisive [sic] whether the foreign income

tax is labeled a gross income or a net income tax . . . . The important thing is

whether the other country is attempting to reach some net gain, not the form in

which it shapes the income tax or the name it gives.” Bank of Am. Nat. Trust &

Sav. Ass’n v. U.S., 459 F.2d 513, 519 (Ct. Cl. 1972) (emphasis added).

Viewed in practicalterms,the Windfall Tax clearly satisfies the realization

and net income requirements. The Windfall Tax is based on revenues from the

ordinary operation of the utilities that accrued long before the design and

implementation of the tax. Revenues from earlier ordinary operation are clearly

“realized;” indeed, the Labour Party accurately estimated the amount the

Windfall Tax would raise, as the earnings of each of the utilities were publicly

available when the Labour Party drafted the tax. Furthermore, the tax only

reached — and only could reach — utilities that realized a profit in the relevant

period, calculating profit in the ordinary sense (e.g. by subtracting operating

expenses associated with generating the utilities’ income). This satisfies the net

income requirement.

The Commissioner’s formalistic argument applies with somewhat greater

force to the gross receipts requirement. A tax actually directed at corporate

value would not, in the ordinary instance, be imposed on the basis of gross

receipts. The Commissioner essentially urges that because Parliament

computed the Windfall Tax based on “profit-making value,” calculated according

to average profits over an initial period, the tax is not designed to reach gross

receipts, even though the tax may be based on gross receipts in some indirect

way. But we are persuaded by the Tax Court’s astute observations as to the

Windfall Tax’s predominant character: the tax’s history and practical operation

were to “claw back” a substantial portion of privatized utilities’ “excess profits”

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in light of their sale value. These initial profits were the difference between the

utilities’ income from all sources less their business expenses — in other words,

gross receipts less expenses from those receipts, or net income. The tax rose in

direct proportion to additional profits above a fixed (and carefully calculated)

floor. That Parliament termed this aggregated but entirely profit-driven figure

a “profit-making value” must not obscure the history and actual effect of the tax,

that is, its predominant character.

Following oral argumentin this case, however, the Third Circuit concluded

to the contrary: that the Windfall Tax fails at least the gross receipts

requirement of the governing regulation, 26 C.F.R. § 1.901-2(a), and is therefore

not a creditable foreign income tax. PPL Corp. v. Comm’r, 665 F.3d 60, 65-66 (3d

Cir. 2011). It regarded the Appellee taxpayer’s mathematical reformulation,

demonstrating the Windfall Tax equated to a 51.75% tax on initial period profits,

as a “bridge too far,” requiring that court to “rewrite the tax rate” to find the

Windfall Tax creditable. PPL, 665 F.3d at 65. The Third Circuit accepted that

perhaps the Windfall Tax reached 23% of 2.25 times the companies’ initial period

profits, but it viewed this as fatal to the gross receipts requirement. Id. Since

a tax must be established on the basis of no more than 100% of gross receipts,

the Third Circuit reasoned, a tax imposed on 23% of 225% of profits could not

satisfy the regulatory requirement. Id. at 67. The Third Circuit viewed

Example 3 of 26 C.F.R. § 1.901-2(b)(3)(ii), disallowing a theoretical credit for a

tax based on 105% the value of extracted petroleum, as bolstering its conclusion:

“[i]f 105% of gross receipts (barely more than actual receipts) does not satisfy the

requirement, then 225% is in the same boat but another ocean.” Id. That court

reversed the Tax Court’s judgment. Id. at 68.

This reasoning exemplifies the form-over-substance methodology that the

governing regulation and case law eschew. The gross receipts requirement

ensures a creditable income tax is usually computed “begin[ning] from actual

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gross receipts, rather than notional amounts.” BITTKER & LOKKEN at ¶ 72.1. 

This distinction between “actual receipts” and “notional amounts” reflects a core

requirement in Section 1.901-2 that creditable foreign taxes must be based on

either actual income or an imputed value not intended to reach more than actual

gross receipts.

This policy arises from a common foreign response to the attempt to avoid

double taxation. Foreign countries would use imputed, rather than actual,

income formulas for income tax purposes “structured to tax artificial or fictitious

income” in order to increase domestic tax receipts. The taxed corporation,

entitled to a dollar-for-dollar foreign tax credit, acted as a conduit from the taxaccrediting nation (e.g. the U.S.) to the nation imposing the tax on fictitious

imputed income instead of actual income. See, e.g., Foreign Tax Credit; Libya

& Saudi Arabia, 1978-1 C.B. 228. The gross receipts requirement therefore

serves as one mechanism to prevent foreign nations from “soaking up” American

tax revenue by levying an income tax on an imputed amount deliberately

calculated to reach some amount greater than the business’s actual gross

receipts. 

Nevertheless, not all methods of imputing income fail to satisfy the gross

receipts requirement. Section 1.901-2(b)(3)(i) indicates that a foreign tax

satisfies the gross receipts requirement if it is imposed either on actual gross

receipts or imputed gross receipts “computed under a method that is likely to

produce an amount that is not greater than fair market value.” Either of these

reflects “actual gross receipts.” Treas. Reg. § 1.901-2(b)(3)(i)(A), (B). A fictitious

calculation likely to produce an amount greater than the fair market value of

actual gross receipts is instead a forbidden fictitious “notional amount.”

A close reading of all of the examples following the subsection establishing

the gross receipts requirement indicates they do not illustrate the meaning of

“actual gross receipts,” but instead differentiate between permissible imputed

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actual gross receipts and impermissible notional amounts. Example 1 considers

a “headquarters company tax” where “arm’s length gross receipts” for a

hypothetical foreign regional headquarters of a nonresident company would be

difficult to actually calculate, and are thus deemed 110% of the business

expenses of the foreign branch. Id. at § 1.901-2(b)(3)(ii) Ex. 1. Because this

formula is designed to produce an amount that is likely not greater than the fair

market value of arm’s-length gross receipts from such transactions with

affiliates,the example concludes thatthe headquarters company tax satisfies the

gross receipts requirement. Example 2 posits a specific circumstance in which

the headquarters tax actually produces an amount much greater than actual

gross receipts’ value. Because a tax either is or is not creditable for all entities

subject to the tax, however, it remains creditable under either Example 1 or 2. 

Example 3 hypothesizes a tax on the extraction of petroleum where the income

value of the petroleum is deemed to be 105% of the fair market value of the

petroleum: i.e. deliberately greater than actual gross receipts. The petroleum

extraction tax is obviously a method for computing an impermissible notional

amount greater than actual gross receipts. Because this imputation is fictionally

exaggerated, inflating the amount subject to foreign taxation, it is not creditable.

The Windfall Tax relies on no Example 3-type imputed amount,nor indeed

on any imputation, for calculating gross receipts. Instead, the Windfall Tax

begins by taking 23% of the daily average of profit based on actual gross receipts,

multiplied by a statutory constant of nine (deemed a “price-to-earnings ratio”),

less each company’s flotation value. No more and no less. The Windfall Tax at

no point imputes gross receipts against the utilities as difficult to calculate or

impractical to know; in fact, by all accounts, the Labour Party forecasted the

estimated revenue from the Windfall Tax with extreme accuracy, because the

various utilities’ earnings information was long since public before the Windfall

Tax was even proposed. There was no need to calculate imputed gross receipts;

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gross receipts were actually known. And thus, an example detailing an

impermissible method for calculating imputed gross receipts (based on historical

practices by OPEC countries) is facially irrelevant. 

In fact, as the record indicates, each utility could only be subject to the

Windfall Tax after making a profit exceeding approximately an 11% annual

return on its initial flotation value, and the Windfall Tax liability increased

linearly with additional profits past that point. Moreover, the Third Circuit

opinion seems to overlook that a tax based on actual financial profits in the U.K.

sense necessarily begins with gross receipts, as, again, the record here indicates. 

London Electricity’s profit for purpose of the Windfall Tax was calculated by

computing gross receipts less operating expenses. The Windfall Tax was

designed to reach a subset of this leftover amount by beginning with an amount

predicated on actual gross receipts minus flotation value.

Furthermore, an examination of the origins of the 2.25 multiplier, which

the Third Circuit asserts as “proof” that the tax was computed on amounts

exceeding gross receipts, illustrates that it had nothing to do with inflating the

utilities’ profits into notional amounts. But see PPL Corp. v. Comm’r, 665 F.3d

60, 65-66 (3d. Cir. 2011). The 2.25 multiplier resulted from dividing the number

of days in a year by approximately the number of days in four years — or,

simplified, one-quarter. This number was multiplied by nine — the price-toearnings ratio — to result in 2.25 (times profits). By the Third Circuit’s logic,

had the Windfall Tax applied to the first nine years after flotation, rendering the

initial period approximately 3,285 days (and the divisor one-ninth), the

“multiplier” would have been (approximately) 1, and the Windfall Tax would

suddenly qualify for dollar-for-dollar credit under Internal Revenue Code § 901. 

But the Third Circuit illogically holds that a Windfall Tax for eight years, or

four, as in this case, is in entirely “another ocean” and may not be credited. We

are always chary to create a circuit split, Wheeler v. Pilgrim’s Pride Corp., 591

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F.3d 355, 363 (5th Cir. 2009), but we cannot engage in this sort of formalism in

light of the predominant character standard. We therefore disagree with the

Third Circuit’s conclusion and hold that the Windfall Tax is a creditable foreign

income tax under I.R.C. § 901.

CONCLUSION

We conclude that when judged on its predominant character, the Windfall

Tax is based on excess profits — realized income derived from gross receipts less

deductions for substantial business expenses incurred in earning those receipts. 

This satisfies the three-part net gain requirement, as the Tax Court accurately

noted. We therefore AFFIRM the judgment of the Tax Court.

AFFIRMED.

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