2011 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

12-22-2011

PPL Corp v. Commissioner of Internal Reven

Precedential or Non-Precedential: Precedential

Docket No. 11-1069

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PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

_______________

No. 11-1069

_______________

PPL CORPORATION AND SUBSIDIARIES

v.

COMMISSIONER OF INTERNAL REVENUE

Appellant

_______________

Appeal from the Decision of the 

United States Tax Court

Docket No. 07-25393

Tax Court Judge: Honorable James S. Halpern

_______________

Argued September 22, 2011

_______________

Before: AMBRO, CHAGARES and

*GARTH, Circuit Judges

(Opinion filed : December 22, 2011)
2

Thomas J. Clark, Esquire

Gilbert S. Rothenberg, Esquire

Francesca U. Tamami, Esquire (Argued)

United States Department of Justice

Tax Division

950 Pennsylvania Avenue, N.W.

P.O. Box 502

Washington, DC 20044

Counsel for Appellant

Mark B. Bierbower, Esquire

Timothy L. Jacobs, Esquire

Richard E. May, Esquire (Argued)

Hunton & Williams LLP

2200 Pennsylvania Avenue, N.W.

Washington, DC 20037

Counsel for Appellee

Alan I. Horowitz, Esquire

Miller & Chevalier Chartered

655 Fifteenth Street, N.W., Suite 900

Washington, DC 20005

Counsel for Amicus Appellee

_______________

OPINION OF THE COURT

_______________
3

AMBRO, Circuit Judge

The Commissioner of Internal Revenue appeals a 

decision of the United States Tax Court holding that PPL 

Corporation was entitled to a foreign tax credit for the 1997 

tax year under § 901 of the Internal Revenue Code. We agree 

with the Commissioner that the foreign tax before us does not 

qualify for a foreign tax credit, and thus reverse.

I. Background

PPL is a Pennsylvania corporation. In 1997, it held a 

25% stake in SWEB (formerly South Western Electricity 

Board), a utility in the United Kingdom. SWEB was one of 

32 United Kingdom companies subject to a one-time 

“windfall tax.” After it paid that tax, PPL claimed under 

I.R.C. § 901 a foreign tax credit on its United States tax 

return. We must decide whether the U.K. windfall tax is an 

“income, war profits, [or] excess profits” tax within the 

meaning of § 901(b)(1).

The windfall tax emerged from a backlash against the

privatization of British utilities and transit operators. The 

U.K.’s Government, then controlled by the Conservative 

Party, sold SWEB and 31 other state-owned companies to 

private investors between 1984 and 1996. Though privately 

owned, the utilities remained regulated. In particular, the 

U.K. Government set the rates at which the utilities would 

sell electricity to customers. With the pricing scheme, it

induced the new private owners to provide electricity more 

efficiently; every pound sterling that the owners could save 

would go to them as profit rather than to customers as lower 

prices. Most of the utilities, including SWEB, increased 

efficiency to a greater degree than the U.K. Government had 

expected. As a result, the utilities’ profits and their share 
4

prices increased. Executive compensation also increased, as 

it was tied in many cases to share prices. These high profits 

and compensation packages, coupled with the fixed costs that 

customers paid under the regulatory scheme, left the public 

unhappy with the utilities and their executives.

The opposition Labour Party sought to capitalize on 

this public discontent by introducing a new tax. Party leaders 

promised a “windfall levy on the excess profits of the 

privatised utilities,” in the words of Labour’s 1997 Election 

Manifesto. They put Geoffrey Robinson, a Labour Member 

of Parliament, in charge of the plan. He hired accounting 

firm Arthur Andersen to develop a series of proposals. 

Robinson and the Andersen team rejected simpler proposals, 

including taxes on gross receipts or on profits, and instead 

selected the “windfall tax” now at issue. Gordon Brown, then

the Shadow Chancellor of the Exchequer, approved 

Robinson’s windfall tax proposal, and Parliament enacted it 

without substantive change after Labour won the 1997 

elections.

In concept, the windfall tax was a one-time 23% tax on 

the difference between each company’s “profit-making 

value” and its “flotation value,” the price for which the U.K. 

Government had sold it. (The public believed that the 

Government had sold the companies too cheaply, hence the 

“windfall.”) The tax statute defined each company’s “profitmaking value” as its average annual profit multiplied by its 

price-to-earnings ratio. It defined average annual profit as the 

company’s average profit per day over a statutorily defined 

“initial period” (which for SWEB and most others was the 

first four years after privatization) multiplied by 365. Rather 

than using the companies’ actual price-to-earnings ratios, the 

statute imputed a ratio of 9 for all companies. This “ratio,” a 

U.K. Government document explained, “approximates to the 

lowest average sectoral price-to-earnings ratio of the 
5

companies liable to the tax.” J.A. at 264. We may express 

the tax algebraically in this way:

Tax = 23% x [(365 x (P / D) x 9) - FV],

where 23% is the tax rate, P is the company’s total profit over 

the “initial period,” D is the length of the initial period in 

days, and FV is the company’s flotation value (to repeat, the 

price for which the U.K. Government sold the company).

SWEB paid the windfall tax, and PPL filed with the 

IRS a claim for refund seeking a foreign tax credit for PPL’s 

share of the windfall tax paid. In 2007, the IRS denied PPL’s 

claim for refund and issued a notice of deficiency. PPL then 

filed a petition in the Tax Court to challenge the IRS’s 

determination that it was not entitled to a credit under I.R.C. 

§ 901 for PPL’s share of SWEB’s windfall tax. The Tax 

Court held a trial and, after post-trial briefing and further 

testimony, agreed with PPL that it was entitled to a foreign 

tax credit. The Commissioner timely appealed to our Court, 

asserting that § 901 does not cover the windfall tax.

The Tax Court had jurisdiction under I.R.C. §§ 6213 

and 6214, and our Court has jurisdiction under I.R.C. 

§ 7482(a)(1). “We have plenary review over the Tax Court’s 

legal conclusions, and may set aside findings of fact if they 

are clearly erroneous.” Capital Blue Cross v. Comm’r, 431 

F.3d 117, 123-24 (3d Cir. 2005).

II. Discussion

A. The Applicable Test

To determine whether the U.K. windfall tax is a 

creditable foreign tax, we start with I.R.C. § 901(b)(1). That 

subsection provides a tax credit for “the amount of any 

income, war profits, and excess profits taxes paid or accrued 
6

during the taxable year to any foreign country.” Congress 

first enacted these words in 1918, and it has not changed them 

since. See Phillips Petroleum Co. v. Comm’r, 104 T.C. 256, 

284 (1995) (discussing legislative history). In the decades 

that followed, “the word ‘income’ in section 901(b)(1) 

[became] the subject of a long and tortuous history” in case 

law that was “permeated” with “vagaries, confusion, and 

seeming contradictions.” Bank of Am. Nat’l Trust & Sav. 

Ass’n v. Comm’r, 61 T.C. 752, 759 (1974).

The Treasury Department explained and clarified

§ 901(b)(1) in a 1983 regulation, Treasury Regulation 1.901-

2, which the parties agree governs our case. We follow our 

sister Courts of Appeals in according it the force of law. See, 

e.g., Texasgulf, Inc. v. Comm’r, 172 F.3d 209 (2d Cir. 1999); 

Amoco Corp. v. Comm’r, 138 F.3d 1139 (7th Cir. 1998).

The regulation’s purpose is to define “income, war 

profits, [or] excess profits tax” within the meaning of I.R.C. 

§ 901(b)(1). The regulation combines those statutory terms 

into the single concept of an “income tax.” Treas. Reg. § 

1.901-2(a)(1). It provides that a foreign assessment is an 

“income tax” if it has the “predominant character . . . of an 

income tax in the U.S. sense.” Id. § 1.901-2(a)(1)(ii). (It also

requires that the foreign tax be a “tax,” which is not at issue 

here.) The regulation then provides that a foreign assessment

has a tax “character” if it is “likely to reach net gain in the 

normal circumstances in which it applies.” Id. § 1.901-

2(a)(3)(i). And it is “likely to reach net gain . . . if and only if

the tax, judged on the basis of its predominant character,”1

 1 Because the regulation repeats the phrase “predominant 

character” throughout its definitions, both the Tax Court and 

PPL on appeal suggest that it applies a “predominant 

character standard” independent of the three requirements. 
7

satisfies each of three requirements: the “realization”

requirement, the “gross receipts” requirement, and the “net 

income” requirement. Id. § 1.901-2(b)(1) (emphases added).

The realization requirement is that the tax is imposed 

on or after the occurrence of events that would result in the 

realization of income under U.S. tax law. Id. § 1.901-2(b)(2). 

 

That is incorrect. We must assess whether a foreign tax 

satisfies each of the regulation’s three requirements “judged 

on the basis of its predominant character.” Treas. Reg. 

§ 1.901-2(b)(1), (b)(2), (b)(3), (b)(4). We may not, however, 

simply ask whether the “predominant character” of a foreign 

tax is that of a U.S. income tax without addressing the 

requirements. The Court of Claims did essentially that in a 

pair of cases that predated the Treasury regulation governing 

our case. See Inland Steel Co. v. United States, 677 F.2d 72, 

80 (Ct. Cl. 1982) (per curiam); Bank of Am. Nat’l Trust & 

Sav. Ass’n v. United States, 459 F.2d 513, 519 (Ct. Cl. 1972).

A single paragraph in the Treasury regulation’s 

preamble purports to adopt both the Court of Claims’ 

approach and the three-requirement test. Creditability of 

Foreign Taxes, 48 Fed. Reg. 46,272, 46,273 (Oct. 12, 1983). 

Those two approaches to § 901 are, at the least, in tension 

with one another. We resolve this tension in favor of the text 

of the regulation, which does not include the preamble. In 

doing so, we follow the Second Circuit’s decision in 

Texasgulf, which considered the same foreign tax that the 

Court of Claims had in Inland Steel but reached the opposite 

result, the former deciding that the Ontario Mining Tax was 

creditable under § 901, Texasgulf, 172 F.3d at 216-17, and the 

latter ruling that it was not, Inland Steel, 677 F.2d at 87.
8

The gross receipts requirement is that the tax is imposed on 

gross receipts or an amount not greater than gross receipts. 

Id. § 1.901-2(b)(3). The net income requirement is that

computing the tax demands deducting from gross receipts the 

costs and expenses incurred in earning those receipts. Id.

§ 1.901-2(b)(4). We determine whether each requirement is 

met “judged on the basis of [the] predominant character” of 

the tax. Id. § 1.901-2(b)(2), (b)(3), (b)(4). We do so mindful

that “[b]ecause § 901’s exemption from taxation is ‘a 

privilege extended by legislative grace,’ it is strictly 

construed.” Texasgulf, 172 F.3d at 214 (quoting Inland Steel 

Co. v. United States, 677 F.2d 72, 79 (Ct. Cl. 1982) (per 

curiam)).

The three requirements concern the timing and the 

base of the foreign tax. The realization requirement, one of 

timing, ensures that the taxpayer has received income before 

being obligated to pay taxes on it. See Helvering v. Horst, 

311 U.S. 112, 115 (1940) (“‘[R]ealization’ is not deemed to 

occur until the income is paid.”). The main effect of this 

requirement is to exclude from “income” the appreciation in 

value of property that its owner has not yet sold. The gross 

receipts and net income requirements present questions about 

the tax base, the amount on which the tax is levied. The 

amount that a particular corporation owes is the product of its 

tax base multiplied by its tax rate.

B. The Tax Base

The parties offer dueling perspectives on the base of 

the windfall tax. In the Commissioner’s view, the tax base is 

what the U.K. statute says it is: the difference between two 

imputed values of each affected company. The first value is 

the company’s “profit-making value,” defined as its average 

annual profit during its “initial period” (that is, average profit 

per day over the initial period, multiplied by 365) times 9, the 
9

assumed price-to-earnings ratio. The second value is the 

company’s “flotation value,” the amount for which the U.K.

Government sold the company to investors. Neither value 

represents the company’s gross receipts, nor does the tax base 

account for recognizable costs and expenses such as 

employee costs. Thus, the Commissioner contends, the 

“windfall tax” fails to meet either the gross receipts or the net 

income requirement under the U.S. regulation.

In PPL’s view, looking through the form of the tax to 

its substance reveals that “the [t]ax [i]s, in substance, a tax on 

profits, specifically on excess profits.” PPL Br. at 43 (citation 

and internal quotation marks omitted). Our classification of a 

foreign tax hinges on its economic substance, not its form. 

See Boulware v. United States, 552 U.S. 421, 429 (2008) 

(“[T]ax classifications . . . turn on ‘the objective economic 

realities of a transaction rather than . . . the particular form the 

parties employed’; a ‘given result at the end of a straight path 

is not made a different result . . . by following a devious 

path.’”) (citations omitted). PPL’s expert testimony purports 

to establish that initial-period profit would satisfy the gross 

receipts and net income requirements.

In our view, PPL’s formulation of the substance of the 

U.K. windfall tax is a bridge too far. No matter how many of 

PPL’s proposed simplifications we may accept, we return to a 

fundamental problem: the tax base cannot be initial-period 

profit alone unless we rewrite the tax rate. Under the 

Treasury Department’s regulation, we cannot do that.

PPL’s proposal and its fatal flaw are best understood in 

algebraic terms. Once again, the U.K. statute computes each 

company’s tax thus:

Tax = 23% x [(365 x (P / D) x 9) - FV],
10

where 23% is the tax rate, P is the company’s initial-period 

profit, D is the length of the initial period in days, and FV is 

the company’s flotation value. Were this a tax on initialperiod profit, as PPL contends that it is in substance, the tax 

base would be simply P, so that we could express the tax 

thus:

Tax = 23% x P.

No amount of emphasis on substance over form can take us

from the first equation to the second.

If profit is in essence the only variable in the tax base, 

we would first need to explain away the other two variables 

that the U.K. statute puts there. For the sake of argument, we 

do so as PPL suggests. First, we assume that the “initial 

period” for all companies is 1,461 days long—in other words, 

that D equals 1,461. Twenty-nine of the 32 affected 

companies had initial periods of 1,461 days—four years (4 x 

365) plus one day for leap year—or just shy of it. Second, we 

assume that each company’s flotation value (the variable FV)

is not relevant for the purpose of satisfying the regulation’s 

three requirements. PPL contends that we should do so 

because the flotation value in the U.K. windfall tax merely 

gives that tax the form of historical “excess profits” taxes.

2

 2 Section 901(b)(1) establishes a credit for “any income, war 

profits, and excess profits taxes” paid to a foreign nation. As 

we noted above, the relevant Treasury regulation treats those 

three taxes as though they are identical. Treas. Reg. § 

1.901-2(a)(1). PPL protests that the regulation “does not 

address the elements necessary to [distinguish] ‘excess 

profits’ from ‘normal profits.’ . . . . One must search [beyond 

the regulation] to determine the predominant character of an 
11

These two modifications would make the tax base 

appear to be quite different. Rather than the statutory 

formula, that is,

Tax = 23% x [(365 x (P / D) x 9) - FV],

we would confront this new formula:

Tax = 23% x [(365 x (P / 1,461)) x 9],

because we have substituted 1,461 for D and eliminated FV. 

And because P is the only variable left, we may combine the 

remaining numbers in the tax base. Multiplying 365 by 9, 

 

excess profits tax.” PPL Br. at 36. In other words, PPL 

submits, the regulation cannot tell us what an “excess profits” 

tax is because it does not define that term specifically. 

Instead, we are invited to look to World War I-era “excess 

profits” taxes, which, we are told, would render flotation 

value irrelevant to our analysis.

But this argument merely suggests that the regulation 

misinterprets the statute. The regulation expressly defines an 

excess profits tax as an “income tax,” which for the purposes 

of the regulation is a tax that satisfies the realization, gross 

receipts, and net income requirements. PPL could have 

argued that the Treasury Department’s regulation was 

arbitrary or capricious because it mingles “excess profits 

taxes” with the other statutory terms. But it did not. Instead, 

PPL agrees with the Commissioner that Treasury Regulation 

1.901-2 governs this case. See id. at 30-33, 35, 52. We 

nonetheless indulge for the sake of argument PPL’s 

contention that historical practice allows us to cast flotation 

value aside. Doing so does not affect our holding.
12

then dividing by 1,461, equals roughly 2.25. Thus, we could

express the U.K. windfall tax even more simply:

Tax = 23% x [2.25 x P].

PPL’s two proposed simplifications boil down to this 

formula.

Even accepting those simplifications, this tax base 

would violate the gross receipts requirement under the 

following logic:

The tax base that PPL’s two simplifications produce is 

2.25 times profit;

Profit equals gross receipts minus expenses;

Thus the tax base that PPL’s two simplifications 

produce is 2.25 times gross receipts minus 2.25 times 

expenses;

The gross receipts requirement addresses the income 

portion of a tax base, whereas the net income 

requirement addresses the expense portion of a tax 

base; and

Hence the income portion of this tax base—2.25 times 

gross receipts—violates the gross receipts requirement, 

which limits the basis of a tax to gross receipts or an 

approximation thereof “likely to produce an amount 

that is not greater than [their] fair market value.” 

Treas. Reg. § 1.901-2(b)(3)(B) (emphasis added).

PPL attempts to skirt this logic by changing the tax 

rate. A 23% tax on 2.25 times profit, PPL observes, is 

mathematically identical to a 51.75% tax on profit, because

23% times 2.25 equals 51.75%. PPL Br. at 25-26. In other 
13

words, returning to our formula, PPL would make one last 

modification:

Tax = 23% x [2.25 x P] = 51.75% x P.

Rewritten in this way, the tax base is profit alone. This tax 

base, PPL posits, would not offend the gross receipts 

requirement because the starting point for calculating profit is 

gross receipts.

However, changing the tax rate in this way to avoid a 

problem with the tax base would read the gross receipts

requirement out of the regulation. This we decline to do. An 

example from the Treasury regulation illustrates why our law 

does not tolerate such a mathematical maneuver. In the 

example, another country imposes a tax on the extraction of 

petroleum. Treas. Reg. § 1.901-2(b)(3)(ii), Ex. 3. The 

country deems “gross receipts” to equal 105% of the market 

value of the petroleum extracted. That is, the starting point 

for the tax base is 105% of each affected company’s gross 

receipts from petroleum. The regulation disallows a credit for 

the tax because it “is designed to produce an amount that is 

greater than the fair market value of actual gross receipts.” 

Id. As the tax would not even be creditable up to the amount 

imposed on 100% of gross receipts, less associated costs, the 

entirety of the tax fails to satisfy the requirement. This all-ornothing result is so because the regulation mandates that “a 

tax either is or is not an income tax, in its entirety, for all 

persons subject to the tax.” Id. § 1.901-2(a)(1)(ii) (emphasis 

added). If 105% of gross receipts (barely more than actual 

receipts) does not satisfy the requirement, then 225% is in the 

same boat but another ocean.

In this example, as with the U.K. windfall tax, 

manipulating the tax rate could in theory fix the problem. 

Say that the tax rate on the hypothetical extraction tax is 20%. 
14

It is true that a 20% tax on 105% of receipts is 

mathematically equivalent to a 21% tax on 100% of receipts, 

the latter of which would satisfy the gross receipts 

requirement. PPL proposes that we make the same move 

here, increasing the tax rate from 23% to 51.75% so that there 

is no multiple of receipts in the tax base. But if the regulation 

allowed us to do that, the example would be a nullity. Any

tax on a multiple of receipts or profits could satisfy the gross 

receipts requirement, because we could reduce the starting 

point of its tax base to 100% of gross receipts by imagining a 

higher tax rate. The regulation forbids that outcome.3

 3 To repeat, a tax must satisfy the regulation’s three 

requirements to be creditable. A tax’s failure to satisfy any 

one of the three tests renders it not creditable, regardless 

whether it satisfies the other two tests. Because the U.K. tax 

fails to satisfy the gross receipts requirement, it is not 

creditable. Nonetheless, we also believe that (laying aside 

any discussion of the net income requirement) the tax fails to 

satisfy the realization requirement. To meet that test, the tax 

must be imposed “[u]pon or subsequent to the occurrence of 

events (‘realization events’) that would result in the 

realization of income . . . .” Treas. Reg. § 1.901-

2(b)(2)(i)(A). The “income” that PPL asserts is at issue here 

is initial-period profit. But as we have explained, the amount 

being taxed (the “income”) was greater than initial-period 

profit. The U.K. windfall tax did not ensure that the 

companies had actually realized the amount being taxed. In 

SWEB’s case, for example, initial-period profit was £306.2 

million, but the taxable amount was approximately £393.1 

million after subtracting flotation value. SWEB did not 

realize the full latter amount as profit over its initial period. 

See Eisner v. Macomber, 252 U.S. 189, 211 (1920) (holding 
15

III. Conclusion

Even if we accept PPL’s contention that the U.K. 

windfall tax is in substance a 23% tax on 2.25 times profits, 

that tax fails to satisfy at least the gross receipts requirement. 

Without changing the tax rate, the calculation of the tax base 

begins with an amount greater than gross receipts. And we 

may not manipulate the tax rate to address a question about 

the tax base.

Thus, we hold that the windfall tax is not creditable 

and reverse the decision of the Tax Court.

 

that income is not realized unless it “is available for actual 

distribution”). Putting aside the Commissioner’s other 

arguments, this alone belies PPL’s claim that the windfall tax 

meets the realization requirement, as the tax was not imposed 

on past profit (and certainly not on excess profit, which of 

course is less than total profit).