ppl corporation subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date held the united kingdom windfall tax enacted on date and imposed on certain british utilities is a creditable tax under sec_901 i r c verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner richard e may mark b bierbower and timothy l jacobs for petitioner melissa d arndt allan e lang michael c prindible and r scott shieldes for respondent halpern judge ppl corp petitioner is the common parent of an affiliated_group_of_corporations the group making a consolidated_return of income by notice of defi- ciency respondent determined a deficiency of dollar_figure in the group’s federal_income_tax for its taxable calendar_year and also denied a claim_for_refund of dollar_figure the issues for decision are whether respondent properly denied the claim for the refund which is related to the cred- itability of the united kingdom u k windfall tax paid_by petitioner’s indirect u k subsidiary the windfall tax issue included as dividend income a distribution that petitioner received from the same indirect u k subsidiary but which within a few days the subsidiary rescinded and petitioner repaid the dividend rescission issue and denied depre- ciation deductions that petitioner’s u s subsidiary claimed for street and area lighting assets we disposed of the third issue in a previous report 135_tc_176 and we dispose_of the remaining issues here unless otherwise stated all section references are to the internal_revenue_code in effect for and all rule ref- erences are to the tax_court rules_of_practice and proce- dure with respect to the two issues before us here peti- tioner bears the burden_of_proof see rule a findings_of_fact stipulations the parties have entered into a first second and third stipulation of facts the facts stipulated are so found the stipulations with accompanying exhibits are incorporated herein by this reference petitioner has not raised the issue of sec_7491 which shifts the burden_of_proof to the commissioner in certain situations we conclude that sec_7491 does not apply because peti- tioner has not produced any evidence that it has satisfied the preconditions for its application see sec_7491 verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report petitioner’s business and its u k operation petitioner is a pennsylvania corporation that was known during as pp l resources inc it is a global energy company through its subsidiaries it produces electricity sells wholesale and retail electricity and delivers electricity to customers it provides energy services in the united_states in the mid-atlantic and the northeast and in the united kingdom during south western electricity plc sweb a u k private limited_liability_company was petitioner’s indirect subsidiary its principal activities at the time included the distribution of electricity it delivered electricity to approximately million customers in its big_number square- mile service area from bristol and bath to land’s end in cornwall sweb also owned electricity-generating assets privatization of u k companies the conservative party won control of the u k parliament in the elections it retained control through date under the leadership of margaret thatcher and john major between and the conservatives privatized mostly companies that were not monopolies eg manufac- turing companies and for that reason did not require spe- cific economic regulation between and however the u k government privatized more than government- owned companies many of which were monopolies the u k government privatized those companies largely through public flotations share offerings at fixed price offers which involved the transfer of those government- owned enterprises to new public limited companies plcs fol- lowed by what was essentially a sale of all or some of the shares in the new plcs to the public the plcs then became sweb was originally incorporated as a u k public limited_liability_company in but as described infra it was privatized in the appendix shows sweb’s relationship to peti- tioner in the u k government hired investment banks and other advisers to assist it in setting the initial share prices structuring the offers and marketing the shares to investors the new plcs were not subject_to a gains tax on transfers of stock to the general_public a result made possible by an amendment to the then-existing u k law under sec_171 of the u k taxation of chargeable gains act tcga companies within a group generally a parent and its 75-percent-owned subsidiaries may transfer assets between members of the group without incurring a capital_gains charge the effect of tcga sec_171 is to defer the chargeable gain on asset appreciation until a group member transfers the asset outside the group at which point the gain becomes chargeable to that transferor under the tcga as originally enacted however the transfer outside the group of the stock of a group member holding an appreciated asset would not trigger any capital_gains charge to the trans- verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner publicly traded companies listed on the london stock exchange in most cases the floated shares opened for trading at a substantial premium over the price the flotation investors paid for the shares in date the u k government privatized regional electric companies recs including sweb the ordi- nary shares of each rec were offered to the public at dollar_figure per share in connection with the flotation of those shares the u k government-owned companies that were privatized and that ultimately became liable for the windfall tax the privatized utilities or windfall tax companies and the years in which they were privatized are as follows company percent of british telecommunications plc british telecom british gas plc british airports authority water and sewerage companies the wascs the recs percent of national power plc and powergen plc the generating companies scottish power plc and scottish hydro-electric plc the scottish electricity companies northern ireland electricity nie railtrack plc railtrack percent of british energy plc british energy which owned u k nuclear generating stations year regulation of the windfall tax companies the electricity act of c sec_1 created the posi- tion of u k director general of electricity supply a position that professor stephen c littlechild professor littlechild held from its creation in through feror the nongroup transferee meanwhile would receive a basis in the stock that would reflect the value of the underlying asset tcga sec_179 was enacted to make the tax consequences of the stock transfer similar to those of the asset transfer although only if the transfer of the stock of the group member holding the asset occurred within years of that member’s acquisi- tion of the asset because the transfers of the stock of the privatized utilities to the general pub- lic pursuant to the flotations of that stock would have triggered the application of tcga sec_179 and taxation of the appreciation inherent in the assets the companies received from the var- ious u k government-owned enterprises parliament specifically exempted the privatization share transfers from the application of that provision professor littlechild was professor of commerce and head of the department of industrial economics and business studies university of birmingham on leave to from to and honorary professor from until verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report before that appointment in the u k secretary of state asked professor littlechild for his advice on how to regulate british telecom in the light of its impending privatization professor littlechild recommended a regulatory scheme which regulated prices rather than as in the united_states maximum profits or rates of return the premise of the scheme which became known as rpi - x was that if the government fixed prices but not profits for a set number of years the privatized companies would have an incentive to reduce costs to maximize profits during that period prices would be reset presumably downward at the start of the next regulatory period to garner for consumers the fruits of the prior period’s cost reductions profits might in a sense become excessive during any regulatory period because a company achieved greater-than-anticipated savings and there was no mechanism for mid-period correc- tion but balance would be reestablished at the start of the next period the goal was to increase efficiency encourage competition and protect consumers under rpi - x prices were not allowed to increase during the regulatory period except to allow for inflation ie increases in rpi less an amount the x factor which did not vary during the period intended to reflect expected increasing efficiency the u k government set the x factors for the first regu- latory periods just before the initial privatization to be effec- tive for what was in most cases the 5-year period after privatization industry regulators subsequently reset the x factors typically every or years in some cases particu- larly where investment requirements were high eg in the case of companies that had underinvested while under public ownership the x factor might be positive rpi x that was the case for most of the recs and wascs each of the regulatory bodies for the privatized utilities followed the rpi - x regulatory method which was adopted for of the windfall tax companies the exceptions being the generating companies on date the rpi - x methodology as applied to the recs came into effect for the 5-year period ending date as noted supra because the recs were in need of large capital_expenditure sec_5 rpi which stands for retail price index is comparable to the cpi consumer_price_index used for various purposes in the united_states verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner during the initial 5-year period the u k government set price controls for the recs in the form of rpi x ie it pro- vided for annual increases in electricity distribution charges above the rate of inflation rather than reductions in those charges utility profits share prices and executive compensation during the initial postprivatization period during the initial postprivatization period the initial period the privatized utilities were able to increase effi- ciency and reduce operating costs to a greater degree than had been expected when the initial price controls were estab- lished that ability led to higher-than-anticipated profits which in turn led to higher-than-anticipated dividends and share price increases for the privatized utilities the large profits dividends and share price increases resulted in sharply increased compensation_for utility directors and executives which in some cases arose through their share ownership and through bonus schemes the popular press referred to those executives as fat cats the public viewed the privatized utilities’ initial period profits as excessive in relation to their flotation values it also viewed the initial period compensation paid to the direc- tors and executives of those companies as excessive those concerns as well as the increases in dividends and share prices resulted in considerable public pressure on the utility industry regulators to intervene and take action that would result immediately in lower prices before the expiration of the initial 5-year period but because the incentive for increased efficiency and ultimately lower prices depended on the regulators’ not intervening until the end of the defined price control period the regulators resisted that pressure and did not act until the end of the initial period at which point they did tighten price controls and thereby transfer the ben- efit of reduced prices to utility customers despite those price adjustments the public retained a strong feeling that the privatized utilities had unduly profited from privatization among the privatized utilities the recs and the wascs were particularly profitable during the initial period in that they recovered nearly all over percent for the wascs and over percent for the recs of their shareholders’ initial investment at flotation within the first years verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report and that customers had not shared equally in the gains therefrom development of the windfall tax although the labour party had been fundamentally opposed to privatization particularly with respect to the utilities by the party reasoned that because it would be costly and given that much of the voting public had embraced share ownership potentially unpopular re- nationalization of those companies when the party regained control of the government was unrealistic the issue then was how the party might best channel the public concerns into developing policy as early as the british press reported that the policy of an incoming labour party might include a ‘windfall’ tax on the profits of privatized utilities such as gas and elec- tricity by the idea of a windfall tax had become a reg- ular feature in all labour party speeches and programs and in the party campaigned on a platform promising that it would impose a windfall tax on the previously privatized utilities and implement a welfare-to-work youth employment training program that the windfall tax would fund specifically the labour party’s election manifesto contained the following promise we will introduce a budget to begin the task of equipping the british economy and reforming the welfare state to get young people and the long-term unemployed back to work this welfare-to-work programme will be funded by a windfall levy on the excess profits of the privatised utilities in date before the issuance of that manifesto certain members of the labour party’s shadow treasury team which included geoffrey robinson mr robinson a member of par- liament began designing the u k windfall tax legislation that the party would introduce to parliament in the likely event that it won the election to that end mr robin- son commissioned members of the tax consulting firm arthur andersen the andersen team to assist the labour party’s shadow treasury team in developing the tax the andersen team consisted principally of stephen hailey christopher osborne mr osborne and christopher wales dr wales the tax that the andersen team devised was essentially the verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner windfall tax that parliament enacted in date mr osborne and dr wales were the most involved members of the andersen team during their initial consideration of the design of the wind- fall tax the andersen team proposed three simple and three complex solutions for structuring the tax the simple solutions were to tax either turnover gross_receipts assets or profits the complex solutions were to tax excess profits excess shareholder returns or a windfall amount the team members rejected the three simple solutions and the first two complex solutions for a variety of reasons for example they considered that a straightforward tax on profits if prospective would pose a risk of financial manipulation by the target companies and therefore uncertainty as to its yield a risk of public percep- tion that it would compromise existing corporate tax reliefs and if retrospective a risk of criticism that it constituted a second tax on the same profits and although mr robinson and the andersen team considered that there was ample rationale for a straightforward tax on either excess profits or excess shareholder returns they concluded that the negative aspects excess amounts the need for a retrospective tax to be assured of raising a target amount and in the case of a tax on excess shareholder returns the likelihood of taxing the wrong shareholders ie shareholders who did not realize those returns outweighed the positive ones eg the difficulty in computing the as a result of the perceived difficulties with the other approaches mr robinson and the andersen team settled on the idea of a tax that would be a one-time or in u k par- lance a one-off tax on the windfall to the privatized utilities on privatization the approach would be to impute a value to each company at privatization using an appro- priate price-to-earnings ratio for each company’s profits during the first years after flotation recognize the wind- fall the difference between the imputed value and the flota- tion price as value forgone by taxpayers and tax the privatized utilities on that windfall using established prin- ciples from capital_gains_tax legislation they reasoned that in date in a presentation to gordon brown labour’s next chancellor of the ex- chequer and the labour party’s shadow treasury team the andersen team set forth the aver- continued verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report such a tax would factor in the privatized utilities’ excess profitability the discount on privatization the unanticipated efficiency gains and the perceived weakness of the initial regulatory regime in date the foregoing proposal was reviewed and approved by gordon brown who became chancellor of the exchequer when labour returned to power in and the labour party’s shadow treasury team and after the labour party regained power in by the u k treasury_department the parliamentary drafters who drafted the actual legislative language after which the draft legislation was disseminated to members of parliament and enacted in date inland revenue and description of the windfall tax on date parliament enacted the windfall tax it constituted part i of chapter finance no act the act and provided in clause as follows - every company which on 2nd date was benefitting from a windfall from the flotation of an undertaking whose privatisation involved the imposition of economic regulation shall be charged with a tax to be known as the windfall tax on the amount of that windfall windfall tax shall be charged at the rate of per cent schedule to this act which sets out how to quantify the windfall from which a company was benefitting on 2nd date shall have effect clause makes clear that the windfall tax is to apply to the privatized utilities clause provides for the administra- tion of the tax by the commissioners of inland revenue clause covers the relationship between the windfall tax and profit-related pay schemes under the then-existing u k law and clause sets forth the definitions of terms used in part i paragraph sec_1 and of schedule referred to in clause provide in pertinent part as follows age price-to-earnings ratios for the various privatized utility groups during the first years after privatization which ranged from a high of after-tax and pre-tax both for the scottish electricity companies to a low of after-tax for the wascs and pre-tax for the recs the presentation also set forth the potential revenue yield from using price-to-pre-tax earnings ratios of through to ascertain the imputed values of the companies and showed that a poten- tial revenue yield of billion could be achieved by using for that purpose either a pre-tax ratio of or an after-tax ratio of dollar_figure coupled with a 33-percent windfall tax_rate on the excess of the imputed value over the flotation price verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner - where a company was benefitting on 2nd date from a windfall from the flotation of an undertaking whose privatisation involved the imposition of economic regulation the amount of that windfall shall be taken for the purposes of this part to be the excess if any of the amount specified in sub-paragraph a below over the amount specified in sub-paragraph b below those amounts are the following amounts that is to say- a the value in profit-making terms of the disposal made on the occasion of the company’s flotation and b the value which for privatisation purposes was put on that disposal value of a disposal in profit-making term sec_2 - the value in profit-making terms of the disposal made on the occasion of a company’s flotation is the amount produced by multi- plying the average annual profit for the company’s initial period by the applicable price-to-earnings ratio for the purposes of this paragraph the average annual profit for a company’s initial period is the amount produced by the following formula- a p d where- a is the average annual profit for the company’s initial period p is the amount of the total profits for the company’s initial period and d is the number of days in the company’s initial period for the purposes of this paragraph the applicable price-to-earnings ratio is paragraph defines value put on a disposal for privatisation purposes ie the flotation value paragraph provides for an appropriate percentage reduction of a com- pany’s value in profit-making terms and its flotation value where less than percent of the company’s ordinary share capital was offered for disposal on the occasion of the com- pany’s flotation paragraph sets forth the criteria for determining a company’s total profits for a company’s initial period and generally provides that those profits are its after- tax profits for financial reporting purposes as determined under relevant provisions of the u k companies act paragraph defines the term initial period in relation to a company as the period encompassing the company’ sec_4 financial years after flotation or such lesser period of exist- the parties stipulate that profit for a windfall tax company’s initial period was equal to the company’s profit on ordinary activities after tax as determined under u k financial_accounting principles and standards and as shown in the company’s profit and loss accounts prepared in accordance with the u k companies act of as amended verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report ence for companies operating for less than financial years after privatization and before date paragraph provides for the apportionment of the windfall amount sub- ject to tax between companies that previously had been a single privatized company lastly paragraph defines the term financial year and other terms for purposes of the windfall tax legislation the act required that affected companies pay the windfall tax in two installments one-half on or before date and the other half on or before date public statements regarding the windfall tax on date gordon brown then chancellor of the exchequer gave the budget speech announcing the windfall tax and he described the windfall tax as follows our reform to the welfare state-and the programme to move the unemployed from welfare to work-is funded by a new and one-off windfall tax on the excess profits of the privatised utilities in determining the details of the tax i believe i have struck a fair bal- ance between recognising the position of the utilities today and their under-valuation and under-regulation at the time of privatisation the windfall tax will be related to the excessively high profits made under the initial regime a company’s tax bill will be based on the difference between the value that was placed on it at privatisation and a more realistic market valu- ation based on its after-tax profits for up to the first full accounting years following privatisation also on date inland revenue issued an announce- ment describing the tax as follows the chancellor today announced the introduction of the proposed windfall tax on the excess profits of the privatised utilities the one-off tax will apply to companies privatised by flotation and regulated by statute the tax will be charged at a rate of per cent on the difference between com- pany value calculated by reference to profits over a period of up to four years following privatisation and the value placed on the company at the time of flotation the expected yield is around billion pounds the inland revenue announcement also stated that the price-to-earnings ratio of approximates to the lowest aver- from this point forward the term initial period refers to the 4-year windfall tax initial period rather than the 5-year initial postprivatization period under the rpi - x regulatory re- gime verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner age price earnings ratio of the taxpaying companies during the relevant periods grouped by sector around that same time her majesty’s treasury issued a publication entitled explanatory notes summer finance bill which describes in detail the various clauses of the windfall tax and which contains a section entitled back- ground stating the introduction of the windfall tax is in accordance with the commit- ment in the government’s election manifesto to raise a tax on the excess profits of the privatised utilities the profits made by these companies in the years following privatisation were excessive when considered as a return on the value placed on the companies at the time of their privatisation by flotation this is because the companies were sold too cheaply and regulation in the relevant periods was too lax the windfall tax will raise around billion and fund the govern- ment’s welfare to work programme parliamentary debate preceding enactment of the windfall tax mr robinson in opening the debate in the house of com- mons on the windfall tax legislation offered the following introductory observations clause heads a group of provisions that together introduce the windfall tax thus meeting the commitment that we made in our election manifesto to introduce a windfall levy on the excess profits of the privatised utilities those companies were sold too cheaply so the taxpayer got a bad deal their initial regulation in the period immediately following privatisation was too lax so the customer got a bad deal as a result the companies were able to make profits that represented an excessive return on the value placed on them at the time of their flotation we are now putting right the failures of the past by levying a one-off tax the yield of around billion will fund our welfare-to-work programme and the new deal that we have announced for the young long-term unemployed and schools clause provides a one-off charge set at a rate of per cent it also gives effect to schedule which will be debated in standing committee it may be helpful if i set the clause in context by explaining briefly how the wind- fall tax works windfall tax is charged on the difference between the value of the com- pany calculated by reference to the profits made in the initial period after privatisation and the value placed on the company at the time of privatisation the value of the company is calculated by multiplying the average annual profit after tax for normally the first four financial years verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report after flotation by a price-to-earnings ratio of nine that ratio approximates to the lowest average sectoral price-to-earnings ratio of the compa- nies liable to the tax the conservative party shadow chancellor of the exchequer peter lilley mp mr lilley summarized his party’s opposition to the windfall tax and in particular clause imposing the tax as follows we have four major criticisms of the clause and the windfall tax that it initiates first the clause makes it clear that the tax will not be borne by the so-called fat cats and speculators criticisms of whom justified its introduction secondly it makes no meaningful attempt to define what is a windfall and should therefore bear the tax thirdly it increases instead of reduces cost to customers any improved profitability should be passed on to customers in the form of lower prices finally it is retrospective arbitrary and symptomatic of the government’s belief in arbitrary govern- ment rather than in government by known and predictable rules mr lilley’s comments during the debate illustrate his understanding of how the tax would affect the privatized utilities they the government have taken average profits over four years after flotation if those profits exceed one ninth of the flotation value the com- pany will pay windfall tax on the excess and further essentially the windfall tax boils down to a tax on success companies that failed to improve their profitability over the said period will pay much less or even no windfall tax other members of the conservative party repeated the idea that the windfall tax was a tax on profits or on success several labour party members defended the tax as a legitimate method of recouping the difference between what should have been charged for the privatized utilities at the time of the various privatizations and the actual flotation prices for example one such member mr hancock observed the overwhelming majority of people have embraced the tax because most think that they were ripped off in the first place when the companies were sold the companies were sold at hopelessly undervalued prices at a time when most people felt that the companies were better and safer in the hands of the public sector the legitimacy of the tax among the general verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner public is that they feel that they are getting back what they should have had in the first place another mr stevenson echoed mr hancock’s remarks i asked the library to do some research on the difference between the pro- ceeds from privatization of the utilities not including the railways and their stock market share price the minute they were floated i asked the library to tot up the difference it was almost billion at the outset of privatisation and it has increased over the years so the snapshot figure of billion by which the government undersold public assets and there- fore robbed the public is a conservative estimate overall effect of the windfall tax on the windfall tax companies thirty-one of the thirty-two windfall tax companies had a windfall tax_liability none of the companies that paid windfall tax had a windfall tax_liability that exceeded its total profits over its initial period twenty-nine of those thirty-two companies had initial periods of full financial years twenty-seven of those twenty-nine companies had ini- tial periods consisting of big_number days ie three 365-day years and one 366-day leap year the other of those compa- nies had initial periods of big_number days and big_number days respectively the remaining three companies had initial periods of less than full financial years consisting of big_number days days and in the case of british energy which because of low initial profits paid no windfall tax days respectively effect of the windfall tax on sweb before the enactment of the windfall tax sweb met with members of the shadow treasury team which included mr robinson and the andersen team in an effort to influence the development of the windfall tax sweb’s then treasurer charl oo sthuizen mr oo sthuizen was the sweb officer principally engaged in that effort upon the announcement of the windfall tax sweb realized that its liability for the tax would greatly exceed its prior estimates thereof and it inves- tigated ways of reducing that liability sweb determined that it could reduce its windfall tax_liability if it could reduce its the parties stipulated an initial period of big_number days although that would seem to exceed years even taking into account a leap year verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report earnings for the 4-year initial period to that end sweb identified a theretofore unidentified liability of million for tree-trimming costs trees interfered with its distribution network that sweb should have taken account of in deter- mining its earnings for its fiscal_year ended date sweb’s outside auditor approved a restatement of its earnings and after an initial objection inland revenue did as well sweb filed its windfall tax_return with inland revenue on date and paid its big_number windfall tax_liability which was based on full financial years totaling big_number days as required in two installments on date and the first installment was paid day after the close of sweb’s tax_year for u s federal_income_tax pur- poses ending date opinion i the windfall tax issue a principles of creditability pursuant to sec_901 and b a domestic corpora- tion may claim a foreign_tax_credit against its federal_income_tax liability for the amount of any income_war_profits_and_excess_profits_taxes paid_or_accrued during the taxable_year to any foreign_country we must decide whether the windfall tax constitutes a creditable income or excess_profits_tax under sec_901 in 104_tc_256 we described the background purpose and function of the foreign_tax_credit provisions of the internal_revenue_code as follows the foreign_tax_credit provisions were enacted primarily to mitigate the heavy burden of double_taxation for u s_corporations operating abroad who were subject_to taxation in both the united_states and foreign coun- tries 285_us_1 54_tc_1233 these provisions were originally designed to produce uniformity of tax burdens among u s tax- payers irrespective of whether they were engaged in business abroad or in the united_states h rept 83d cong 2d sess a sec- ondary objective of the foreign_tax_credit provisions was to encourage or at least not to discourage american foreign trade h_r rept 65th verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner cong 2d sess c b part 221_f2d_134 2d cir affg 19_tc_879 taxes imposed by the government of any foreign_country were initially fully deductible in computing net taxable_income pursuant to our income_tax law of revenue act of ch 38_stat_114 specific foreign taxes became creditable pursuant to the revenue act of the foreign taxes that are presently creditable pursuant to sec_901 specifically income_war_profits_and_excess_profits_taxes have remained unchanged and are the same taxes that were creditable in revenue act of ch sec_222 40_stat_1073 the definition of income_war_profits_and_excess_profits_taxes has evolved case by case the temporary and final regulations adopted rel- atively recently outline the guiding principles established by prior case law the supreme court in 302_us_573 established the principle uniformly followed in subsequent caselaw and enshrined in the regulations that in deciding whether a foreign tax is an income_tax for purposes of sec_901 the term income_tax will be given meaning by referring to the u s income_tax system and measuring the foreign tax against the essential features of that system the phrase income taxes paid as used in our own revenue laws has for most practical purposes a well understood meaning it is that meaning which must be attributed to it the final regulations referred to in phillips petroleum are the regulations that were issued in were in effect in the year in issue and remain in effect today some- times the regulations sec_1_901-2 income_tax regs is entitled income war profits or excess_profits_tax paid_or_accrued paragraph a thereof is entitled definition of income war profits or excess_profits_tax and in pertinent part it provides as fol- lows adopting the term income_tax to refer to an income war or excess_profits_tax in general 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 paragraph a further provides that with exceptions not rel- evant to this case a tax either is or is not an income_tax in its entirety for all persons subject_to the tax verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report in pertinent part sec_1_901-2 income_tax regs defines the term predominant character as follows the predominant character of a foreign tax is that of an income_tax in the u s sense i f within the meaning of para- graph b of this section the foreign tax is likely to reach net gain in the normal circumstances in which it applies in pertinent part sec_1_901-2 income_tax regs provides 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 predomi- nant character satisfies each of the realization gross_receipts and net_income requirements set forth in paragraphs b b and b respectively of this section pursuant to sec_1_901-2 income_tax regs as pertinent to this case a foreign tax satisfies the realization requirement if judged on the basis of its predominant character it is imposed u pon or subsequent to the occurrence of events realization events that would result in the realization of income under the income_tax provisions of the internal_revenue_code pursuant to sec_1_901-2 income_tax regs as pertinent to this case a foreign tax satisfies the gross_receipts requirement if judged on the basis of its predomi- nant character it is imposed on the basis of g ross receipts pursuant to sec_1_901-2 income_tax regs a foreign tax satisfies the net_income requirement if judged on the basis of its predominant character the base of the tax is computed by reducing gross_receipts to permit- a recovery_of the significant costs and expenses attributable to such gross_receipts or b recovery_of such significant costs and expenses computed under a method that is likely to approximate or be greater than recovery_of such significant costs and expenses sec_1_901-2 income_tax regs further provides a foreign tax law permits recovery_of significant costs and expenses even if such costs and expenses are recovered at a different time than they would be if the internal_revenue_code applied unless the time of e g items deductible under the internal_revenue_code and capitalized and amortized under the foreign tax system verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner recovery is such that under the circumstances there is effectively a denial of such recovery a foreign tax law that does not permit recovery_of one or more significant costs or expenses but that provides allowances that effectively compensate for nonrecovery of such significant costs or expenses is considered to permit recovery_of such costs or expenses a foreign tax whose base is gross_receipts or gross_income does not satisfy the net_income requirement except in the rare situation where that tax is almost certain to reach some net gain in the normal circumstances in which it applies because costs and expenses will almost never be so high as to offset gross_receipts or gross_income respectively and the rate of the tax is such that after the tax is paid persons subject_to the tax are almost certain to have net gain the secretary first adopted the predominant character standard in the regulations in the preamble to those regulations the preamble the secretary stated that the standard adopts the criterion for creditability set forth in 677_f2d_72 ct_cl 459_f2d_513 ct_cl and 61_tc_752 t d 1983_2_cb_113 in the cases the secretary cited in the preamble and in other more recent cases the issue or test regarding the status of a foreign tax as a creditable income_tax appears to be whether the foreign tax in question is designed to and does in fact reach net gain in the normal circumstances in which it applies thus in 459_f2d_513 bank of america i which the secretary cites in the preamble the court of claims in considering the creditability of a gross_income tax that on its face was not a tax on net_income or gain concluded that such a tax could be creditable under certain circumstances we do not however consider it all-decisive whether the foreign_income_tax is labeled a gross_income or a net_income_tax or whether it specifically allows the deduction or exclusion of the costs or expenses of realizing the profit 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 in certain situations a levy can in reality be directed at net gain even though it is imposed squarely on gross_income that would be the case if it were clear that the costs expenses or losses_incurred in making the gain would in all probability always or almost so be the lesser part of the gross_income in that situation there would verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report always or almost so be some net gain remaining and the assessment would fall ultimately upon that profit in 677_f2d_72 also cited in the preamble the court of claims relying on its earlier decision in bank of america i emphasized the purpose of the foreign_country in designing the tax to reach net gain to qualify as an income_tax in the united_states sense the foreign_country must have made an attempt always to reach some net gain in the normal circumstances in which the tax applies the label and form of the foreign tax is not determinative in 61_tc_752 affd without published opinion 538_f2d_334 9th cir the third case the sec- retary cites in the preamble we described the analysis of the court of claims in bank of america i as distilling the governing test to determine whether a foreign_income_tax qualifies as a creditable income_tax within the meaning of sec_901 ie whether the tax was designed to fall on some net gain or profit that test we added is the proper one to apply id moreover courts have construed the regulations in a manner consistent with the analysis in bank of america i for example the court_of_appeals for the second circuit in 172_f3d_209 2d cir 107_tc_51 texasgulf i consid- ered the creditability of the ontario mining tax omt which imposed a graduated_tax on ontario mines to the extent that profit as defined for omt purposes exceeded a statutory exemption in determining profit for omt purposes tax- payers were allowed to deduct an allowance for profit in respect of processing processing allowance in lieu of certain expenses that were attributable to omt gross_receipts but the test the court of claims adopted for the creditability of a foreign gross_income tax the virtual certainty of net gain is specifically incorporated in the regulations see sec_1 b i income_tax regs quoted supra as the court_of_appeals for the second circuit stated in 172_f3d_209 2d cir 107_tc_51 texasgulf i the pre- amble to the regulations reaffirms inland steel’s general focus upon the extent to which a tax reaches net gain in texasgulf ii the court_of_appeals found creditable under the pre- dominant character standard in the regulations a tax the ontario mining tax that the court of claims in 677_f2d_72 had found noncreditable before the promulgation of those regulations see discussion infra verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner that were not recoverable under the tax nonrecoverable expenses the taxpayer had presented empirical evidence to show that across the industry the processing allowance was likely to exceed nonrecoverable expenses for the tax years at issue in answer to the commissioner’s objection that the taxpayer had not shown anything more than an accidental relationship between the processing allowance and the non- recoverable expenses the court_of_appeals stated at bottom the commissioner’s argument is that the type of quantitative empirical evidence presented in this case is not relevant to the creditability inquiry however the language of sec_1 901-2-specifically effectively com- pensate and approximates or is greater than -suggests that quan- titative empirical evidence may be just as appropriate as qualitative ana- lytic evidence in determining whether a foreign tax meets the net_income requirement we therefore hold that empirical evidence of the type pre- sented in this case may be used to establish that an allowance effectively compensates for nonrecoverable expenses within the meaning of sec_1 b id pincite fn ref omitted the court_of_appeals concluded given the large size and representative nature of the sample considered these statistics suffice to show that the tax_court did not clearly err in finding that the processing allowance was likely to exceed nonrecoverable expenses for the tax years at issue texasgulf has therefore met its burden of proving that the predominant character of the omt is such that the processing allowance effectively compensates for any nonrecoverable costs id pincite in reaching their decisions both the court_of_appeals and this court distinguished inland steel co v united_states supra which held the same omt to be noncreditable the former distinguished that case on the ground that it was decided before the promulgation of sec_1_901-2 income_tax regs and in particular before the adoption of the rule that a foreign tax law that provides allowances that effec- tively compensate for non-recovery of significant costs or expenses is considered to permit recovery_of such costs and expenses texasgulf ii f 3d pincite we distinguished inland steel not only on that ground but also on the ground that the case was governed by the predomi- nant character test which replaced the substantial equiva- lence test under which inland steel was decided texasgulf i t c pincite in reaching that conclusion we stated that use of the predominant character and effectively com- verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report pensates tests represented a change from the history and purpose approach used in cases decided before the regu- lations applied a factual quantitative approach id pincite in 113_tc_338 we considered the creditability of the u k petroleum revenue tax prt under sec_901 and the regulations we found that a purpose of the prt was to tax extraordinary profits of oil_and_gas companies relating to the north sea id pincite with limited exceptions the tax_base subject_to prt was gross_income relating to oil_and_gas recovery activi- ties less all significant costs and expenses except interest_expense id pincite in lieu of an interest_expense deduc- tion the law provided a deduction for uplift ie amounts equal to percent of most capital expenditures relating to a north sea field id pincite with respect to the predominant character of the tax we found the purpose administration and structure of prt indicate that prt constitutes an income or excess_profits_tax in the u s sense id pincite we stated that the evidence at trial showed that special allowances and reliefs under prt significantly exceed the amount of disallowed_interest_expense for exxon and other oil companies and we quoted the testimony of the u k government_official who first pre- sented prt to the u k house of lords for formal consider- ation that ‘of course this tax prt represents an excess_profits_tax ’ id pincite we rejected as irrelevant the commissioner’s contention that a company-by-company anal- ysis showed that most of the companies operating in the north sea did not have uplift allowance greater than or equal to the disallowed_interest_expense and we agreed with exxon that the prt was designed to tax excess profits from north sea oil_and_gas production which generally were earned by major oil_and_gas companies which owned the largest and most profitable fields in the north sea id pincite we then noted that the vast majority of those companies had uplift allowance in excess of nonallowed interest_expense id finally we concluded that the predominant the denial of a deduction for interest was designed to prevent the use of intercompany debt to avoid or minimize liability for the tax 113_tc_338 earlier in exxon corp v commissioner supra pincite in discussing the predominant char- acter standard we made the following observation regarding sec_1_901-2 income_tax regs the regulations provide that taxes either are or are not to be regarded as income taxes verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner character of prt constitutes an excess profits or income_tax in the u s sense creditable under sec_901 id b arguments of the partie sec_1 petitioner’s arguments petitioner argues that given the historical development design and actual operation of the windfall tax it constitutes a creditable tax on excess profits petitioner rejects respondent’s view that in determining the creditability of the windfall tax we are constrained by the text of the statute rather petitioner argues that we may consider extrinsic evidence of the purpose and effect of the tax as applied to the windfall tax companies as petitioner states the determination of whether a foreign tax is designed to fall on some net gain or profit depends on the substance and not the form or label of the tax in support of its position petitioner relies in large part on the decisions of this court in exxon corp v commissioner supra texas- gulf i and 104_tc_256 in each of which we considered evidence of the purpose design and operation of the foreign tax in question in considering creditability with respect to the development and design of the tax petitioner offers the trial testimony of professor littlechild two members of the andersen team mr osborne and dr wales and an exhibit constituting mr robinson’s trial testi- mony in entergy corp v commissioner tcmemo_2010_198 filed today which also involves the creditability of the windfall tax petitioner notes that professor littlechild’s testimony establishes that he designed the regulatory system rpi - x that allowed the privatized utilities to realize the higher-than-anticipated profits during the initial period after flotation petitioner also notes that both mr osborne and dr wales members of the andersen team who testified as experts regarding the regulatory and political concerns that led to enactment of the windfall tax stated that the in their entirety for all persons subject_to the taxes see sec_1_901-2 income_tax regs re- spondent does not interpret this provision as requiring that in order to qualify as an income_tax a tax in question must satisfy the predominant character test in its application to all tax- payers rather respondent interprets this provision as requiring that in order to qualify as an income_tax a tax must satisfy the predominant character test in its application to a substantial number of taxpayers verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report rationale for the tax was the perceived excess profits the privatized utilities earned during the initial period and the actual form of the tax was adopted for presentational reasons mr robinson’s testimony in entergy is consistent with that of mr osborne and dr wales and it reaches the same principal conclusion the intent was to tax the excess profits of the privatized utilities petitioner also offers the testimony of mark ballamy mr ballamy and edward maydew professor maydew both experts in accounting the former the founder of a u k accounting firm the latter a professor of accounting at the university of north carolina petitioner claims that the sum and substance of mr ballamy’s testimony which dealt with u k financial_accounting concepts under the windfall profits tax statute establishes that the windfall tax fell on the excess profits of the windfall tax companies during their initial periods and that all of these profits represented realized profits professor maydew testified regarding u k and u s financial_accounting concepts and that the windfall tax was in substance a tax on income similar in operation to prior u s and u k excess profits taxes petitioner claims that professor maydew’s testimony confirms that of mr ballamy that the u k and u s concepts of realization are fundamentally the same thereby satisfying the regulations’ realization requirement petitioner’s final expert witness was stewart c myers professor myers professor of finance at mit’s sloan school of management professor myers’ research and teaching focus is in part on the valuation of real and financial_assets petitioner points to professor myers’ testimony that the dif- ferences in windfall tax_payments by the privatized compa- nies cannot be explained by differences in flotation value or by changes in value after flotation and that the tax operated as an excess-profits tax not as a tax on value change in value or undervaluation dr wales testified that during a date meeting with gordon brown the andersen team demonstrated the presentational linkage that could be made between the mechanics of the tax the underlying rationale for the tax ie a tax on the privatized utilities’ initial period excess profits and the popular notion of undervalue at privatisation as part of his testimony professor myers employed a series of scatter plot diagrams to dem- onstrate that there was at best a very loose relationship between the windfall tax the privatized utilities paid and changes in their actual market values after privatization but very tight and direct relationships between the windfall tax_payments and the cumulative initial period earnings_of those companies and the windfall tax_payments and what professor verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner the fact petitioner also offered testimony of mr oo sthuizen sweb’s treasurer during the period leading up to the enactment of the windfall tax in and before that sweb’s tax manager mr oo sthuizen recognized that under the windfall tax formula for every pound that profits were reduced in an initial period year sweb received percent of that amount back as a reduction in its windfall tax_liability he also was involved in sweb’s decision to act on that knowledge by obtaining permission from its auditors and after an initial objection inland revenue to restate its accounts for its fiscal_year the final year of sweb’s initial period by expensing as a reserve million of pro- jected tree-trimming costs which saved sweb over million of projected windfall tax petitioner also notes mr oo sthuizen’s recognition that the windfall tax operated as an excess_profits_tax in that regard mr oo sthuizen testified as follows in effect the way the tax works is to say that the amount of profits you’re allowed in any year before you’re subject_to tax is equal to one-ninth of the flotation price after that profits are deemed excess and there is a tax that’s how the tax works it has a definition of what is allowable profit and what is excess profits and it taxes the excess lastly petitioner notes that it is possible to restate the windfall tax formula algebraically to make clear that it oper- ates as an excess_profits_tax imposed on of the wind- fall tax companies at an approximately 7-percent rate in that regard petitioner points to a series of stipulations in myers determined to be the cumulative initial period excess profits of the recs and the wascs professor myers also testified that the term value in profit-making terms as defined in the windfall tax statute is not a standard economic term or concept and it has no meaning in any other context moreover he believes that it does not represent a true economic value of any of the privatized utilities rather he believes that it constituted a one-off device created to deter- mine tax_liability he further testified the privatized companies were valued daily on the london stock exchange the designers of the windfall tax could have used stock-market values to identify with hindsight the under- valuation of the companies on or after their ipo dates instead they settled on a formula in which the chief moving part was not value but profits professor myers rejects respondent’s argument discussed infra that value in profit-making terms because it is calculated using a reasonable price-to-earnings multiple is the product of an acceptable valuation technique in professor myers’ view is not an accurate p e multiple and it is not applied to current or expected future earnings therefore ‘value-in-profit- making terms’ cannot measure the economic value that companies could would or should have had mr oo sthuizen testified that a government press release describing the windfall tax prompted sweb to restate its accounts for its fiscal_year mr oo sthuizen and professors maydew and myers make the same point verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report which the parties agree that that is in fact the case in particular petitioner points to the parties’ stipulation that the windfall tax formula for companies with a full big_number day initial period can be rewritten pursuant to the following steps where p is the total initial period profits and fv is the flotation value statutory windfall tax formula tax p big_number - fv windfall tax formula-modification tax p - fv windfall tax formula-modification tax p - fv petitioner also points out that instead of a cumulative reformulation of the windfall tax for the entire initial period the tax can be reformulated by showing its application with respect to each year of that period as follows where p1 p2 etc represent profits for year year etc tax p1 - fv p2 - fv p3 - fv p4 - fv petitioner argues that the foregoing mathematical and algebraic reformulations of the windfall tax as enacted show that in substance it was a tax imposed at a 71-percent rate on the profits for each windfall tax company’s initial period to the extent those profits exceeded an average annual respondent objects to certain of those stipulations on the ground that the reformulations are neither the statutory equivalent of the equation set forth in the windfall tax act nor an appropriate application of the equation in the act and on the further ground that the stipulations are irrelevant and immaterial respondent does not object to the mathematical equivalence of the reformulations for the sake of simplicity here and in modification big_number days divided by days is deemed to equal rather than the more accurate again for the sake of simplicity dollar_figure percent represents big_number or approximately which is approximately and the dollar_figure percent represents big_number percent or approximately which is approximately of the 23-percent windfall tax_rate as professor myers points out to get from modification to modification one need only multiply all terms inside the brackets in modification by and the percent tax_rate by with the windfall tax amount remaining unchanged because the dollar_figure percent reflects the multiplier for the leap year of days assumed for demon- strative purposes to be year verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner return of approximately percent of the company’s flota- tion value petitioner acknowledges and the parties have stipulated with respondent lodging the same objections regarding lack of statutory equivalency appropriateness relevancy and materiality that of the windfall tax companies had ini- tial periods longer or shorter than big_number days and that for those companies the reformulated rates are different for two of those companies because the number of days in the initial period was very close to big_number days the rate of the reformulated windfall tax was very close to dollar_figure percent and the 4-year return on flotation value to be exceeded for there to be a tax was very close to dollar_figure percent for nie which had an initial period of big_number days those two rates were dollar_figure percent and dollar_figure percent respectively as noted supra british energy had no windfall tax_liability because of insufficient profits during the initial period the fifth com- pany railtrack had an initial period of only days with the result that the effective_tax_rate on its excess profits determined pursuant to the stipulated reformulation of the tax was dollar_figure percent and the cumulative 4-year return on flotation value to be exceeded for there to be a tax was only dollar_figure percent petitioner dismisses any concerns regarding the effect of the reformulated windfall tax on those companies as compared to its uniform effect on the other companies on several grounds for of the companies the dif- ferences are negligible any differences in effective rates are not significant or material in evaluating the overall incidence of the windfall tax because the companies are outliers and therefore must be ignored for purposes of deter- mining creditability under the sec_901 regulations as applied by the court_of_appeals for the second circuit in texasgulf ii and this court in texasgulf i as mr osborne explained the payment of relatively large amounts of windfall tax by companies with initial periods of substan- tially less than big_number days ie nie and railtrack was not a problem because profits earned over the balance of what would have been a full big_number day period referred to by mr osborne as out performance would not be subject_to the tax and the tax did not exceed the realized after-tax profits of any of the windfall tax companies verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report respondent’s arguments respondent argues that the regulations alone control the creditability of the windfall tax because those regulations subsume or supersede prior caselaw and neither require nor permit inquiry into the purpose underlying the enactment of a foreign tax or the history of a foreign taxing statute applying those regulations to this case respondent concludes that according to the actual terms of the windfall tax statute the windfall tax failed to satisfy any of the tests that a foreign tax must satisfy to be considered likely to reach net gain in the normal circumstances in which it applies ie the realization gross_receipts and net_income tests therefore the windfall tax did not have the predominant character of an income_tax in the u s sense in essence respondent’s position is that pursuant to the terms of the statute the windfall tax was not imposed upon or after the occurrence of a realization event for u s tax purposes because the tax was not a direct additional tax on pre- viously-realized earnings rather the tax was imposed on the difference between two company values as a tax imposed on a base equal to the unrealized difference between two defined values rather than directly on realized gross_receipts reduced by deductible expenses respondent argues that it necessarily fails to satisfy any of the three tests respondent flatly rejects petitioner’s claim that under the regulations we may rely on extrinsic evidence relating to the windfall tax’s purported purpose design and ‘substance’ revealed through petitioner’s so-called ‘algebraic reformulation’ of the tax respondent argues that texasgulf ii texasgulf i and 113_tc_338 which did admit extrinsic evidence to dem- onstrate the creditability of foreign taxes should be limited to their facts ie a finding that the alternative cost allow- ances under consideration in those cases effectively com- pensated for the nondeductibility of certain actual expenses pursuant to the requirements of sec_1_901-2 income_tax regs and do not support the use of extrinsic evidence to satisfy a requirement not found in the regula- tions respondent also argues that we should disregard peti- tioner’s algebraic reformulations of the windfall tax statute verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner as merely a hypothetical rewrite of the statute which does not constitute ‘quantitative’ or ‘empirical’ evidence that the tax actually touched net gain as contemplated by this court in texasgulf i or exxon that argument like his argument that we may not consider extrinsic evidence that the actual incidence of the tax was on net_income or excess profits fol- lows from what appears to be the crux of respondent’s posi- tion the windfall tax is unambiguously imposed on the dif- ference between two values and therefore it cannot be a tax on income or profit because for respondent the ‘substance’ of the tax is revealed on the face of the windfall tax statute itself -ie t he words of the u k statute are the ‘substance’ of this tax -he believes that it is not necessary to look beyond those words to give them meaning nevertheless he argues that even assuming the intent of the andersen team and members of parliament might be relevant in characterizing the nature of the windfall tax their intent is as consistent with the statute as written ie a tax on value in excess of flotation proceeds as it is with petitioner’s view that the windfall tax was intended as a tax on excess profits in sup- port of that argument respondent refers to mr robinson’s book describing his life as a member of the labour party entitled the unconventional minister and quotes the following portion of chapter which describes the development and enactment of the windfall tax then in date chris wales had a stroke of inspiration chris simply turned the whole argument on its head the problem was not that the companies had made too much profit nor that they had paid out too much to shareholders and fat-cat directors nor that they had been treated with kid gloves by the regulators that was all true of course but the gen- esis of the problem was that they had been sold too cheaply in the first place why not then argued chris tax the loss to the taxpayer which arose from the sale of these companies at what was a knock-down price in further support of his position that the windfall tax was indeed a tax on the difference between two defined values respondent offers the expert testimony of peter k ashton mr ashton a consultant who was qualified as an expert in economics and valuation methodologies and philip baker qc respondent makes the point on brief as follows the key evidence in this case-the wind- fall tax statute itself-explicitly provides that the windfall tax is imposed on a base of the dif- ference between two values and such formulation fails to satisfy the sec_901 regulations verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report queens counsel mr baker a u k tax lawyer offered as an expert in u k tax legislation and the u k tax system mr ashton viewed the method of computing the statutory value in profit-making terms for each of the windfall tax companies as a generally accepted valuation methodology which he referred to as the market_value multiples method for computing the equity value of a company although mr ashton agreed that in general valuation is a forward- looking proposition he reasoned that the windfall tax meth- odology of fixing value retroactively was acceptable because the draftsmen selected a valuation_date with respect to which they had perfect foresight of what the income is going to be for the windfall tax companies that you can plug in to the valuation formula the substance of mr baker’s testimony was that by its terms the windfall tax was for each windfall tax company a tax on a tax_base equal to the difference between two defined values and that as such it was distinguishable from prior or existing u k taxes on excess profits or capital_gains respondent echoes mr baker’s view that the windfall tax was intentionally imposed on a tax_base measured in part by a value the value in profit-making terms derived retrospectively from known initial period earnings and for that reason criticizes professor myers’ reliance on equity value or market capitalization value as his standard for con- cluding that in relying on value in profit-making terms the windfall tax was not a tax on value as that term is conventionally understood in respondent’s view we need not determine whether the profit-making value formula resulted in a ‘realistic’ valuation of the windfall tax compa- nies in order to determine whether the windfall tax is a creditable tax that is because in respondent’s view profit- making value represented a reasonable approximation of how the windfall tax companies might have been valued at the time of flotation if subsequent earnings could have been known at that time relying on a point that the andersen team made in a date presentation to gor- don brown respondent also argues presumably as an alternative ground for denying a foreign_tax_credit for the windfall tax that the tax was in substance a reenactment of tcga sec_179 see the discussion of that provision in note of this report ie a retroactive tax on the unreal- ized appreciation of the windfall tax companies at the time of privatization respondent argues that because the tax necessarily fails the realization test of the regulations it is noncred- itable we find respondent’s arguments unpersuasive for two reasons first respondent’s own verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner c analysi sec_1 introduction the parties fundamentally disagree as to what we may consider in determining whether the windfall tax is a cred- itable tax for purposes of sec_901 respondent’s view is that we need not indeed may not consider anything other than the text of the windfall tax statute in determining whether that tax is an income_tax within the meaning of sec_1_901-2 income_tax regs b ased on the simple formula employed to levy the tax respondent argues the windfall tax falls on the difference between two values- flotation value and is respondent continues therefore a tax on value and not on income petitioner respondent concludes cannot escape from the plain language of the windfall tax statute profit-making value it petitioner points out that under the cited regulation it is the predominant character of the foreign tax in question that counts to determine the predominant character of the windfall tax petitioner argues that we may consider evidence beyond the text of the statute viz evidence of the design of the tax and its actual economic and financial effect as it applies to the majority of the taxpayers subject_to it in sup- port of that argument petitioner principally relies on three cases this court has decided since the promulgation of the regulations 113_tc_338 expert mr baker specifically disavowed those arguments by flatly stating that the windfall tax was not corporation tax it was a separate tax and it was at the rate of percent instead of the percent corporate tax_rate second we agree with petitioner that even if the wind- fall tax had been intended as in substance a reenactment of tcga sec_179 it would not be a tax on unrealized_appreciation rather it would be a tax on previously realized but unrecog- nized gain and therefore creditable as petitioner points out the operation of sec_171 tcga and sec_179 tcga is substantively similar to the gain deferral and recognition rules relating to intercompany transfers in our consolidated_return_regulations sec_1_1502-13 in- come tax regs petitioner argues however that t he windfall tax statute was not designed on the basis of sec_179 tcga respondent’s argument on this basis is unfounded we ac- cept what is in effect petitioner’s concession that the windfall tax should not be considered an income_tax because it resembled or was a reinstatement of tcga sec_179 therefore we do not decide the windfall tax issue on that ground in construing a statute respondent argues the ‘preeminent canon of statutory interpreta- tion requires a court to presume that the legislature says in a statute what it means and means in a statute what it says there ’ quoting 541_us_176 quoting 503_us_249 respond- ent insists that ‘when the statute’s language is plain the sole function of the courts -at least where the disposition required by the text is not absurd- is to enforce it according to its terms ’ quoting 530_us_1 quoting 489_us_235 verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report texasgulf i and 104_tc_256 for the reasons that follow we think that petitioner has the better argument and we find that the windfall tax is a creditable income_tax under sec_901 nature of the predominant character standard respondent’s text-bound approach to determining the cred- itability of the windfall tax is inconsistent with the regulations’ description of the predominant character standard for creditability under which the predominant character of a foreign tax is that of an income_tax in the u s sense i f the foreign tax is likely to reach net gain in the normal circumstances in which it applies sec_1_901-2 income_tax regs by implicating the cir- cumstances of application in the determination of the predominant character of a foreign tax the drafters of the regulations clearly signaled their intent that factors extrinsic to the text of the foreign tax statute play a role in the determination of the tax’s character in determining the predominant character of a foreign tax we may look to the actual effect of the foreign tax on taxpayers subject_to it the inquiry being whether the tax is designed to and does in fact reach net gain in the normal circumstances in which it applies regardless of the form of the foreign tax as reflected in the statute that interpretation of the regulations’ predominant char- acter standard is consistent with caselaw preceding the issuance of the regulations and in particular two of the cases cited in the preamble to those regulations as pro- viding the criterion for creditability embodied in that standard 677_f2d_72 and bank of america i see supra p of this report in the former case the court of claims stated that a foreign tax will qualify as an income_tax in the u s sense if the foreign_country has made an attempt always to reach some net gain in the normal circumstances in which the tax applies the label and form of the foreign tax is not determinative inland steel co v united_states supra pincite f 2d pincite emphasis added the court noted that the issue as framed under its analysis in bank verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner of america i is whether taxation of net gain is the ultimate objective or effect of the foreign tax id pincite f 2d pincite emphasis added in bank of america i ct_cl pincite f 2d pincite emphasis added the court of claims stated 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 the facts and analysis of the court of claims in bank of america i nicely illustrate the prevailing pre-1983 standard the case involved in part the creditability of foreign taxes on the taxpayer’s gross_income from the banking business its branch conducted in each of certain foreign countries clearly a gross_income tax is not by its terms a net_income_tax had the court of claims focused solely on the statutory language which in each case levied a tax on the taxpayer’s gross takings or gross_receipts before deduction of any expenses it would have been compelled to hold on that ground alone that none of the taxes under consideration con- stituted a creditable net_income_tax the focus of the court’s inquiry however was not on the text of the statute per se but on the question of whether the tax was attempting to reach some net gain id the court specifically noted that a levy can in reality be directed at net gain even though it is imposed squarely on gross_income id relying on prior judicial decisions internal_revenue_service rulings and gross_income tax levies under federal_law eg sec_871 and sec_1441 the court concluded that an income_tax under sec_901 covers all foreign_income_taxes designed to fall on some net gain or profit and includes a gross_income tax if but only if that impost is almost sure or very likely to reach some net gain because costs or expenses will not be so high as to offset the net profit id pincite f 2d pincite because the gross_income taxes in bank of america i failed to meet that test the court held that they were noncred- itable id pincite f 2d pincite also as noted supra the cases that have applied the regulations’ predominant character standard are consistent with the court of claims’ approach to creditability in inland steel and bank of america i thus in texasgulf i and in as noted supra note the court of claims’ test for the creditability of a gross_income tax is incorporated into the regulations see sec_1_901-2 income_tax regs verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report exxon corp v commissioner supra we relied on quan- titative empirical evidence of the actual effect of the foreign tax on a majority of the taxpayers at whom it was directed and found that in each case the tax was designed to and did in fact reach net gain and therefore constituted a cred- itable income or excess_profits_tax in texasgulf i we distin- guished the result in inland steel co v united_states supra which had held the tax under consideration the ontario mining tax to be noncreditable stating the use of the ‘predominant character’ and ‘effectively compensates’ tests in sec_1_901-2 income_tax regs is a change from the history and purpose approach used in the cases decided before the regulations applied a factual quan- titative approach texasgulf i t c pincite emphasis added we reject respondent’s argument that this court in texas- gulf i and exxon and the court_of_appeals for the second circuit in texasgulf ii strictly limit the use of empirical data to an analysis under the alternative cost_recovery_method of the net_income requirement of sec_1_901-2 income_tax regs it is true that texas- gulf i texasgulf ii and exxon involved the creditability of foreign taxes that started with a statutory tax_base con- sisting of gross_income and that all three relied on extrinsic evidence to show that the foreign law’s allowances in lieu of deductions for expenses actually incurred would effectively compensate for nonrecovery of significant costs or expenses as required by sec_1_901-2 income_tax regs we disagree however with respondent’s conclusion that those cases do not support the use of extrinsic evidence to satisfy a requirement not found in the regulations nothing in those cases would so limit a taxpayer’s right to rely on extrinsic evidence to demonstrate the creditability of a foreign tax and specifically that it satisfied the predomi- nant character standard in texasgulf i texasgulf ii and exxon the narrow issue was whether the statutory allow- ances in question did in fact effectively compensate for the nondeductibility of significant costs or expenses within the meaning of sec_1_901-2 income_tax regs but the overall issue for decision in those cases as in this case was whether the foreign tax was designed to and did in fact reach net gain the only limitation on reliance on extrinsic verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner evidence in any of the three opinions in those cases is the fol- lowing observation by the court_of_appeals for the second circuit in texasgulf ii f 3d pincite n we note however that this case is exceptional in that the relatively small number of taxpayers subject_to the omt made it practicable to compile and present broadly representative industry data spanning a lengthy period we do not suggest that the reliance that we place on empirical evi- dence would be appropriate in cases where such comprehensive data is unavailable far fewer taxpayers were subject_to the windfall tax than were subject_to omt in texasgulf ii and the data after-tax financial profits for the taxpayers subject_to the windfall tax were readily available in the published financial reports of those taxpayers respondent’s argument that we should restrict our inquiry to the text of the windfall tax to determine its predominant character is unpersuasive the predominant character standard as applied to the windfall tax the term value may mean among other things either monetary or material worth or in mathematics an assigned or calculated numerical quantity the american heritage dictionary of the english language 4th ed the parties do not disagree that the amount of the windfall for purposes of determining the windfall tax is in mathematical terms the excess if any of one value value in profit-making terms over another flotation value nor do they disagree that flotation value is real or actual value a value in the first sense they do disagree as to whether value in profit-making terms is a real or actual value relying on its experts’ testimony petitioner argues that it i sec_28 although respondent states that t he use of financial book earnings rather than ‘taxable income ’ in determining the windfall tax companies ’ profit-making value further distin- guishes the windfall tax from a u s excess_profits_tax he does not argue that a foreign tax on financial profits is noncreditable for that reason alone that argument would appear to be invalid in any event in the light of our own corporate alternative_minimum_tax which at one time was calculated in part using financial or book earnings see sec_56 repealed in by the omnibus budget reconciliation act of publaw_101_508 sec a stat moreover differences between book and taxable_income are with rare exception at- tributable to timing differences which are generally disregarded under the regulations see sec_1_901-2 income_tax regs verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report not a real economic value we need not settle that dis- pute because even were we to agree with respondent that value in profit-making terms is a real or actual value that would not necessarily be determinative since our inquiry as to the predominant character of the windfall tax is not text bound indeed however we describe the form of the windfall tax_base our inquiry as to the design and incidence of the tax convinces us that its predominant character is that of a tax on excess profits as an initial matter we note that the parties have stipulated that none of the companies that paid windfall tax had a windfall tax_liability in excess of its total profits over its initial period with respect to design respondent reorders the usual notion at least in architecture that form follows function to argue in essence that form determines function ie that the design of the tax_base the excess of one value over another demonstrates parliament’s decision to enact a tax based on value ie to tax undervaluation on flotation of the windfall tax companies rather than a tax based on income or excess profits we disagree gordon brown’s public statements in his date budget speech the inland revenue and u k treasury announcements and the debate in parliament preceding enactment of the windfall tax make clear that the tax was justified for two essentially equivalent reasons it would recoup excessive profits earned by the privatized utilities during the initial period and it would correct for the undervaluation of those companies at flotation the reasons are equivalent because each subsumes the other that is the essence of the explanation of the windfall tax by her maj- esty’s treasury in its publication entitled explanatory notes summer finance bill the profits made by these companies in the years following privatisation were excessive when considered as a return on the value placed on the companies at the time of their privatisation by flotation this is because the companies were sold too cheaply and regulation in the relevant periods was too lax mr osborne one of petitioner’s expert witnesses and a member of the andersen team in- volved in designing the windfall tax testified that value in profit-making terms is not a real value it is rather a construct based on realised profits that would not have been known at the date of privatisation and a mechanism by which additional taxes on profits could be levied verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner thus profits were considered excessive in relation to the prices at which the windfall tax companies were sold to the public which in turn were deemed to be too low one explanation implies the other it follows then that both par- ties may be said to be correct in their assessment of the polit- ical motivation for the windfall tax of greater significance in terms of the creditability of the windfall tax is the fact that the members of parliament understood that they were enacting a tax that by its terms represented one of two equivalent explanations that under- standing is evidenced by the conservative party shadow chancellor of the exchequer’s mr lilley’s recognition that the government had taken average profits over four years after flotation and i f those profits exceed one ninth of the flotation value the company will pay windfall tax on the excess mr lilly’s understanding that the windfall tax could be characterized as a tax on excess profits is further indicated by his recognition that privatized utilities that failed to improve their profitability over the initial period will pay much less or even no windfall tax just as a levy can in reality be directed at net gain even though it is imposed squarely on gross_income bank of america i ct_cl pincite f 2d pincite so too can a foreign levy be directed at net gain or income even though it is by its terms imposed squarely on the difference between two values and that is what we conclude in the that rather obvious point was also made by mr osborne the rationale for the tax was rooted in the initial period during which excessive profits were made as judged against the companies’ flotation values the nature of the judgment means that there is a logical symmetry between the two available ways of describing the rationale for the tax-that profits were high in relation to the flotation value or that the flotation value was low in relation to profits a classic definition of income from the economic literature is squarely so based income is the money value of the net accretion to one’s economic power between two points of time haig the concept of income-economic and legal aspects the federal_income_tax colum- bia university press robert m haig’s definition was subsequently expressed by another economist henry c si- mons in a way that explicitly included consumption personal income may be defined as the algebraic sum of the market_value of rights exercised in consumption and the change in value of the store of property rights between the beginning and end of the period in ques- tions simons personal income_taxation the simons refinement has come to be known as the haig-simons_definition of income and is widely accepted by lawyers and econo- mists graetz schenk federal income_taxation principles and policies 6th ed a foreign tax imposed on a base conforming to the haig-simons_definition of income viz the value of savings at the end of the period plus consumption during the period minus the value of savings at the beginning of the period would seem to qualify as a tax on net gain under continued verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report case of the windfall tax the architects and drafters of the tax knew exactly which companies the tax would target the publicly reported after-tax financial profits of those companies which were a crucial component of the tax_base and the target amount of revenue the tax would raise therefore it cannot have been an unintentional or fortuitous result that for of the windfall tax compa- nies that paid tax the effective rate_of_tax on deemed annual excess profits was at or near percent and for none of the companies did the tax exceed total initial period profits 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 the companies subject_to it the regulations that the tax_base includes unrealized_appreciation in property is no bar to such qualification see sec_1_901-2 iv example income_tax regs sweb’s ability to reduce retroactively its reported profits for one of its initial period years appears to have been a solitary aberration among the windfall tax companies and does not de- tract from the general conclusion that the initial period financial profits of the windfall tax com- panies were known before enactment because it had an initial period of only days railtrack presents the sole exception to the overall conclusion that the windfall tax viewed as a tax on excess profits affected the tar- geted companies in a reasonable manner as noted supra the effective_tax_rate on railtrack’s excess profits was dollar_figure percent and the cumulative 4-year return on flotation value to be ex- ceeded for there to be a tax was only dollar_figure percent it is clear however that neither the regula- tions nor the cases interpreting them require that the foreign tax mimic the u s income_tax for all taxpayers to achieve creditability under sec_901 only that it satisfy that standard in the normal circumstances in which it applies see sec_1_901-2 income_tax regs see also exxon corp v commissioner t c pincite in which we noted the commissioner’s ac- knowledgment that to qualify as an income_tax a tax must satisfy the predominant character test in its application to a substantial number of taxpayers in that case we found that the u k petroleum revenue tax prt provided a sufficient allowance in lieu of a deduction for interest_expense where for the companies responsible for percent of the prt payments the allowance exceeded nonallowed interest_expense respondent describes petitioner’s algebraic reformulation of the windfall tax as an attempt to rewrite the value-based windfall tax to convert it into a profit-based tax presumably re- spondent would agree that had the tax been enacted as a profit-based tax instead of as a tax on the difference between two values it would have been creditable under that approach the same tax is either creditable or noncreditable depending on the form in which it is enacted a result at odds with the predominant character standard set forth in the regulations and ap- plied in the caselaw if as respondent suggests the real goal of the windfall tax was to recoup on behalf of the public the windfall to the initial investors that arose by virtue of flotation prices well below actual value as perceived with hindsight why did the labour party majority not try to recoup verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner because both the design and effect of the windfall tax was to tax an amount that under u s tax principles may be considered excess profits realized by the vast majority of the windfall tax companies we find that it did in fact reach net gain in the normal circumstances in which it applied and therefore that its predominant character was that of an income_tax in the u s sense see sec_1_901-2 income_tax regs we recognize that in the cases that have either provided the foundation for the predominant character standard eg 677_f2d_72 and bank of america i or applied that standard eg texasgulf i texasgulf ii and 113_tc_338 the tax_base pursuant to the statute was a gross amount or a gross amount less expenses comprising in part allowances in lieu of actual costs or expenses and the issue was whether the statutory tax_base represented net gain for the majority of taxpayers subject_to the foreign tax nevertheless the analysis that led the courts in those cases with the exception of inland steel to deter- mine creditability or noncreditability of the foreign tax in issue is equally applicable in determining the creditability of the windfall tax the question being whether according to an empirical or quantitative analysis the tax was likely to reach net gain in the normal circumstances in which it applied because the facts of this case provide an affirmative answer to that question we find the windfall tax to be creditable the entire windfall or at least a substantial portion of it ie why was the tax_rate not per- cent or something closer to it than the 23-percent rate actually imposed although there is no evidence in the record that would provide a direct answer to that question we find the enact- ment of the relatively low 23-percent rate to be consistent with an awareness of the labour party that it was taxing the companies not the investors who actually benefited from the alleg- edly low flotation prices and a decision on its part that a tax on the companies being in effect a second tax on their initial period profits should be imposed at a reasonable nonconfiscatory rate which would be sufficient to raise the desired revenue that view is of course consistent with petitioner’s argument that the form of the tax was adopted for presentational reasons as we noted in texasgulf i t c pincite the court of claims in 677_f2d_72 did not have industry-wide data to consider and the secretary had not yet promulgated regulations using a quantitative approach and it held the ontario mining tax to be noncreditable because it was not the substantial equivalent of an income_tax a standard for creditability that was modified by the regulations’ adoption of the predominant character standard verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila united_states tax_court report d conclusion the windfall tax paid_by petitioner’s indirect u k sub- sidiary sweb constituted an excess_profits_tax creditable under sec_901 ii the dividend rescission issue the parties submitted the dividend rescission issue fully stipulated on brief petitioner states that if we resolve the windfall tax issue in its favor then petitioner concedes the dividend rescission issue because we have done so we need not address the dividend rescission issue we accept peti- tioner’s concession iii conclusion taking into account our prior opinion in 135_tc_176 decision will be entered under rule petitioner argues that if we resolve the windfall tax issue in its favor then sweb holdings would not have had sufficient earnings_and_profits to pay a taxable dividend any distribution by sweb holdings would thus constitute a nontaxable return_of_capital on brief petitioner states that the tax consequences of such a nontaxable return_of_capital would not in petitioner’s judgment be material for that reason i n the interest of judicial economy peti- tioner does not ask that we decide the dividend rescission issue in its favor if we decide the windfall tax issue in its favor verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila ppl corp subs v commissioner f verdate 0ct date jkt po frm fmt sfmt v files ppl2 sheila s p e o p