The opinion
PPL CORPORATION & SUBSIDIARIES, PETITIONER v.
COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
Docket No. 25393–07. Filed September 9, 2010.
Held: The United Kingdom windfall tax enacted on July 2,
1997, and imposed on certain British utilities is a creditable
tax under sec. 901, I.R.C.
304
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(304) PPL CORP. & SUBS. v. COMMISSIONER 305
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 $10,196,874 in
the group’s Federal income tax for its 1997 taxable (calendar)
year and also denied a claim for refund of $786,804. The
issues for decision are whether respondent properly (1)
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),
(2) 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within a few days, the subsidiary rescinded and petitioner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 (3) 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, PPL Corp. & Subs. v. Commis-
sioner, 135 T.C. 176 (2010), and we dispose of the remaining
issues here.
Unless otherwise stated, all section references are to the
Internal Revenue Code in effect for 1997, 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 142(a). 1
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.
1 Petitioner has not raised the issue of sec. 7491(a), which shifts the burden of proof to the
Commissioner in certain situations. We conclude that sec. 7491(a) does not apply because peti-
tioner has not produced any evidence that it has satisfied the preconditions for its application.
See sec. 7491(a)(2).
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306 135 UNITED STATES TAX COURT REPORT (304)
Petitioner’s Business and Its U.K. Operation
Petitioner is a Pennsylvania corporation that was known
during 1997 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 1997, South Western Electricity plc (SWEB),
a U.K. private limited liability company, was petitioner’s
indirect subsidiary. 2 Its principal activities at the time
included the distribution of electricity. It delivered electricity
to approximately 1.5 million customers in its 5,560-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 1979 elections. It retained control through May 1997,
under the leadership of Margaret Thatcher and John Major.
Between 1979 and 1983, the Conservatives privatized
mostly companies that were not monopolies (e.g., manufac-
turing companies) and, for that reason, did not require spe-
cific economic regulation. Between 1984 and 1996, however,
the U.K. Government privatized more than 50 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. 3 The plcs then became
2 SWEB was originally incorporated as a U.K. public limited liability company in 1987, but,
as described infra, it was privatized in 1990. The appendix shows SWEB’s relationship to peti-
tioner in 1997.
3 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, 1992 (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-
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(304) PPL CORP. & SUBS. v. COMMISSIONER 307
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 December 1990, the U.K. Government privatized 12
regional electric companies (RECs), including SWEB. The ordi-
nary shares of each REC were offered to the public at £2.40
per share in connection with the flotation of those shares.
The 32 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 Year
50.2 percent of British Telecommunications plc (British
Telecom) ............................................................................ 1984
British Gas plc ..................................................................... 1986
British Airports Authority .................................................. 1987
10 water and sewerage companies (the WASCs) .............. 1989
The 12 RECs ........................................................................ 1990
60 percent of National Power plc and Powergen plc (the
generating companies) ..................................................... 1991
Scottish Power plc and Scottish Hydro-Electric plc (the
Scottish electricity companies) ........................................ 1991
Northern Ireland Electricity (NIE) ..................................... 1993
Railtrack plc (Railtrack) ...................................................... 1996
88.5 percent of British Energy plc (British Energy)
which owned U.K. nuclear generating stations) ............ 1996
Regulation of the Windfall Tax Companies
The Electricity Act of 1989, c. 29, 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 1989 through 1998. 4
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 6 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.
4 Professor Littlechild was professor of commerce and head of the Department of Industrial
Economics and Business Studies, University of Birmingham (on leave, 1989 to 1994) from 1975
to 1994 (and honorary professor from 1994 until 2004).
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308 135 UNITED STATES TAX COURT REPORT (304)
Before that appointment, in 1983, 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’’, 5 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 (i.e., 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 4 or 5 years. In some cases, particu-
larly where investment requirements were high (e.g., 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 29 of the 32 windfall tax companies, the exceptions being
the generating companies. On March 31, 1990, the RPI – X
methodology as applied to the RECs came into effect for the
5-year period ending March 31, 1995. As noted supra,
because the RECs were in need of large capital expenditures
5 RPI, which stands for retail price index, is comparable to the CPI (consumer price index)
used for various purposes in the United States.
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(304) PPL CORP. & SUBS. v. COMMISSIONER 309
during the initial 5-year period, the U.K. Government set
price controls for the RECs in the form of RPI + X; i.e., 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, 6
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
6 Among the privatized utilities, the RECs and the WASCs were particularly profitable during
the initial period in that they recovered nearly all (over 90 percent for the WASCs and over
80 percent for the RECs) of their shareholders’ initial investment at flotation within the first
4 years.
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310 135 UNITED STATES TAX COURT REPORT (304)
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 1992 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 1992, 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 1994 the idea of a windfall tax had become a reg-
ular feature in all Labour Party speeches and programs, and,
in 1997, the party campaigned on a platform promising that
it would (1) impose a windfall tax on the previously
privatized utilities and (2) implement a welfare-to-work
youth employment training program that the windfall tax
would fund. Specifically, the Labour Party’s 1997 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 May 1996, 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 1997 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
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(304) PPL CORP. & SUBS. v. COMMISSIONER 311
windfall tax that Parliament enacted in July 1997. 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 (1) turnover (gross
receipts), (2) assets, or (3) profits. The ‘‘complex’’ solutions
were to tax (1) excess profits, (2) excess shareholder returns,
or (3) 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 (e.g., the difficulty in computing the ‘‘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, i.e., shareholders who did not realize those
returns) outweighed the positive ones.
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 5 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. 7 They reasoned that
7 In November 1996, 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
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312 135 UNITED STATES TAX COURT REPORT (304)
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 November 1996, the foregoing proposal was reviewed
and approved by Gordon Brown (who became Chancellor of
the Exchequer when Labour returned to power in 1997) and
the Labour Party’s shadow treasury team, and, after the
Labour Party regained power in 1997, by the U.K. Treasury
Department, Inland Revenue, and the Parliamentary
drafters (who drafted the actual legislative language), after
which the draft legislation was disseminated to members of
Parliament and enacted in July 1997.
Description of the Windfall Tax
On July 31, 1997, Parliament enacted the windfall tax. It
constituted part I of chapter 58, Finance (No. 2) Act 1997
(the Act), and provided, in clause 1, as follows:
1.—(1) Every company which, on 2nd July 1997, 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.
(2) Windfall tax shall be charged at the rate of 23 per cent.
(3) Schedule 1 to this Act (which sets out how to quantify the windfall
from which a company was benefitting on 2nd July 1997) shall have effect.
Clause 2 makes clear that the windfall tax is to apply to the
32 privatized utilities, clause 3 provides for the administra-
tion of the tax by the Commissioners of Inland Revenue,
clause 4 covers the relationship between the windfall tax and
profit-related pay schemes under the then-existing U.K. law,
and clause 5 sets forth the definitions of terms used in part
I.
Paragraphs 1 and 2 of schedule 1, referred to in clause
1(3), provide in pertinent part as follows:
age price-to-earnings ratios for the various privatized utility groups during the first 5 years after
privatization, which ranged from a high of 12.7 after-tax and 9.4 pre-tax (both for the Scottish
Electricity companies) to a low of 9.4 after-tax (for the WASCs) and 7.3 pre-tax (for the RECs).
The presentation also set forth the potential revenue yield from using price-to-pre-tax earnings
ratios of 6 through 8 to ascertain the imputed values of the companies and showed that a poten-
tial revenue yield of £6.4 billion could be achieved by using for that purpose either a pre-tax
ratio of 6 or an after-tax ratio of 8.25 coupled with a 33-percent windfall tax rate on the excess
of the imputed value over the flotation price.
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1.—(1) * * * where a company was benefitting on 2nd July 1997 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 (2)(a) below over the amount specified
in sub-paragraph (2)(b) below.
(2) 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 terms
2.—(1) * * * 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.
(2) 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 = 365 × 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.
(3) For the purposes of this paragraph the applicable price-to-earnings
ratio is 9.
Paragraph 3 defines ‘‘value put on a disposal for
privatisation purposes’’; i.e., the flotation value. Paragraph 4
provides for an appropriate percentage reduction of a com-
pany’s ‘‘value in profit-making terms’’ and its flotation value
where less than 85 percent of the company’s ordinary share
capital was ‘‘offered for disposal on the occasion of the com-
pany’s flotation.’’ Paragraph 5 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 1985. 8
Paragraph 6 defines the term ‘‘initial period’’ in relation to
a company as the period encompassing the company’s 4
financial years after flotation or such lesser period of exist-
8 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 1985, as amended.
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314 135 UNITED STATES TAX COURT REPORT (304)
ence for companies operating for less than 4 financial years
after privatization and before April 1, 1997. 9 Paragraph 7
provides for the apportionment of the windfall amount sub-
ject to tax between companies that previously had been a
single privatized company. Lastly, paragraph 8 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 December 1,
1997, and the other half on or before December 1, 1998.
Public Statements Regarding the Windfall Tax
On July 2, 1997, 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 4 full accounting
years following privatisation.
Also on July 2, 1997, 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 23 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 5.2 billion Pounds.
The Inland Revenue announcement also stated that the
price-to-earnings ratio of 9 ‘‘approximates to the lowest aver-
9 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.
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(304) PPL CORP. & SUBS. v. COMMISSIONER 315
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 1997’’, 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 £5.2 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 1 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 £5.2 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 1 provides a one-off charge, set at a rate of 23 per cent. It also gives
effect to schedule 1, 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
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316 135 UNITED STATES TAX COURT REPORT (304)
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 1 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
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(304) PPL CORP. & SUBS. v. COMMISSIONER 317
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 £6 billion at the outset of
privatisation and it has increased over the years. So the snapshot figure
of £6 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 31 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 4 full financial
years. Twenty-seven of those twenty-nine companies had ini-
tial periods consisting of 1,461 days, i.e., three 365-day years
and one 366-day (leap) year. The other 2 of those 29 compa-
nies had initial periods of 1,456 days and 1,463 days, 10
respectively. The remaining three companies had initial
periods of less than 4 full financial years, consisting of 1,380
days, 316 days, and (in the case of British Energy, which
because of low initial profits, paid no windfall tax) 260 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
10 The parties stipulated an initial period of 1,463 days, although that would seem to exceed
4 years, even taking into account a leap year.
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318 135 UNITED STATES TAX COURT REPORT (304)
earnings for the 4-year initial period. To that end, SWEB
identified a theretofore unidentified liability of £12 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 March 31, 1995.
SWEB’s outside auditor approved a restatement of its 1995
earnings and, after an initial objection, Inland Revenue did
as well.
SWEB filed its windfall tax return with Inland Revenue on
November 7, 1997, and paid its £90,419,265 windfall tax
liability (which was based on 4 full financial years totaling
1,461 days), as required, in two installments, on December 1,
1997 and 1998. The first installment was paid 1 day after
the close of SWEB’s tax year (for U.S. Federal income tax pur-
poses) ending November 30, 1997.
OPINION
I. The Windfall Tax Issue
A. Principles of Creditability
Pursuant to section 901(a) and (b)(1), 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 section 901.
In Phillips Petroleum Co. v. Commissioner, 104 T.C. 256,
283–284 (1995), 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. Burnet v. Chicago Portrait Co., 285 U.S. 1, 9 (1932); F.W. Woolworth
Co. v. Commissioner, 54 T.C. 1233, 1257 (1970). 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. 1337, 83d Cong., 2d Sess. 76 (1954). 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. 767, 65th
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(304) PPL CORP. & SUBS. v. COMMISSIONER 319
Cong., 2d Sess. (1918), 1939–1 C.B. (Part 2) 86, 93; Commissioner v. Amer-
ican Metal Co., 221 F.2d 134, 136 (2d Cir. 1955), affg. 19 T.C. 879 (1953).
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 1913. Revenue Act of 1913, ch. 16, 38 Stat. 114. Specific foreign
taxes became creditable pursuant to the Revenue Act of 1918. The foreign
taxes that are presently creditable pursuant to section 901, specifically,
income, war profits, and excess profits taxes, have remained unchanged
and are the same taxes that were creditable in 1918. Revenue Act of 1918,
ch. 18, sec. 222(a)(1), 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 Biddle v. Commissioner, 302 U.S.
573, 579 (1938), 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 section 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 1983, were in effect in
1997 (the year in issue), and remain in effect today (some-
times, the 1983 regulations).
Section 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):
(1) 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.’’
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320 135 UNITED STATES TAX COURT REPORT (304)
In pertinent part, section 1.901–2(a)(3), 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)(1) of this section, the foreign tax is likely to reach
net gain in the normal circumstances in which it applies’’.
In pertinent part, section 1.901–2(b)(1), 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)(2), (b)(3) and (b)(4),
respectively, of this section.
Pursuant to section 1.901–2(b)(2)(i), 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 section 1.901–2(b)(3)(i), 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 section 1.901–2(b)(4)(i), 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.
Section 1.901–2(b)(4)(i), 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,[11] unless the time of
11 E.g., items deductible under the Internal Revenue Code and capitalized and amortized
under the foreign tax system.
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(304) PPL CORP. & SUBS. v. COMMISSIONER 321
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 1983 regulations. In the preamble to those
regulations (the preamble), the Secretary stated that the
standard:
adopts the criterion for creditability set forth in Inland Steel Company v.
U.S., 677 F.2d 72 (Ct. Cl. 1982), Bank of America National Trust and
Savings Association v. U.S., 459 F.2d 513 (Ct. Cl. 1972), and Bank of
America National Trust and Savings Association v. Commissioner, 61 T.C.
752 (1974). * * * [T.D. 7918, 1983–2 C.B. 113, 114.]
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 Bank of Am. Natl. Trust & Sav.
Association v. United States, 198 Ct. Cl. 263, 274, 459 F.2d
513, 519 (1972) (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
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322 135 UNITED STATES TAX COURT REPORT (304)
always (or almost so) be some net gain remaining, and the assessment
would fall ultimately upon that profit.[12]
In Inland Steel Co. v. United States, 230 Ct. Cl. 314, 325,
677 F.2d 72, 80 (1982), 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: 13
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 Bank of Am. Natl. Trust & Sav. Association v. Commis-
sioner, 61 T.C. 752, 760 (1974), affd. without published
opinion 538 F.2d 334 (9th Cir. 1976), 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
section 901(b)(1); i.e., 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 1983 regulations in a
manner consistent with the analysis in Bank of America I.
For example, the Court of Appeals for the Second Circuit, in
Texasgulf, Inc. v. Commissioner, 172 F.3d 209 (2d Cir. 1999)
(Texasgulf II), affg. 107 T.C. 51 (1996) (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
12 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. 1.901–
2(b)(4)(i), Income Tax Regs., quoted supra.
13 As the Court of Appeals for the Second Circuit stated in Texasgulf, Inc. v. Commissioner,
172 F.3d 209, 216 (2d Cir. 1999) (Texasgulf II), affg. 107 T.C. 51 (1996) (Texasgulf I), the pre-
amble to the 1983 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 1983 regulations a tax, the Ontario Mining Tax, that the
Court of Claims, in Inland Steel Co. v. United States, 230 Ct. Cl. 314, 677 F.2d 72 (1982), had
found noncreditable before the promulgation of those regulations. See discussion infra.
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(304) PPL CORP. & SUBS. v. COMMISSIONER 323
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 § 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 § 1.901–
2(b)(4). [Id. at 216; 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. at 215–216.]
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 section 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, 172 F.3d at 216–217. 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, 107 T.C. at 69–70. In reaching that conclusion we stated
that use of the ‘‘predominant character’’ and ‘‘effectively com-
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324 135 UNITED STATES TAX COURT REPORT (304)
pensates’’ tests represented ‘‘a change from the history and
purpose approach used in cases decided before the 1983 regu-
lations applied a factual, quantitative approach.’’ Id. at 70.
In Exxon Corp. v. Commissioner, 113 T.C. 338 (1999), we
considered the creditability of the U.K. petroleum revenue
tax (PRT) under section 901 and the 1983 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. at 344. 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’’. 14 Id. at 345. In lieu of an interest expense deduc-
tion, the law provided a deduction for ‘‘uplift’’; i.e., ‘‘amounts
equal to 35 percent of most capital expenditures relating to
a North Sea field’’. Id. at 347.
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. at 356. 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. at 357. 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. at
359. We then noted that the vast majority of those companies
‘‘had uplift allowance in excess of nonallowed interest
expense.’’ 15 Id. Finally, we concluded that ‘‘the predominant
14 The denial of a deduction for interest was designed to prevent the use of intercompany debt
to avoid or minimize liability for the tax. Exxon Corp. v. Commissioner, 113 T.C. 338, 345 (1999).
15 Earlier in Exxon Corp. v. Commissioner, supra at 352, 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
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(304) PPL CORP. & SUBS. v. COMMISSIONER 325
character of PRT constitutes an excess profits or income tax
in the U.S. sense’’ creditable under section 901. Id.
B. Arguments of the Parties
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 Phillips Petroleum Co. v. Commissioner, 104 T.C.
256 (1995), 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, T.C. Memo. 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 (1) the
in their entirety for all persons subject to the taxes. See sec. 1.901–2(a), 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.
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326 135 UNITED STATES TAX COURT REPORT (304)
rationale for the tax was the perceived excess profits the
privatized utilities earned during the initial period and (2)
the actual form of the tax was adopted for ‘‘presentational’’
reasons. 16 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.’’ 17
16 Dr. Wales testified that, during a Nov. 6, 1996, 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 [i.e., a tax on the privatized utilities’ initial
period excess profits] and the popular notion of undervalue at privatisation.’’
17 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 (1) the windfall tax payments and the cumulative initial
period earnings of those companies and (2) the windfall tax payments and what Professor
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Petitioner also offered the fact testimony of Mr.
Oo¨sthuizen, SWEB’s treasurer during the period leading up to
the enactment of the windfall tax in 1997 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 51 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 1994–95 fiscal year (the final year of SWEB’s
initial period) by expensing (as a reserve) £12 million of pro-
jected tree-trimming costs, which saved SWEB over £6 million
of projected windfall tax. 18 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 27 of the 32 wind-
fall tax companies) at an approximately 51.7-percent rate. 19
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, ‘‘9 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.’’
18 Mr. Oo ¨ sthuizen testified that a Government press release describing the windfall tax
prompted SWEB to restate its accounts for its 1994–95 fiscal year.
19 Mr. Oo¨ sthuizen and Professors Maydew and Myers make the same point.
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328 135 UNITED STATES TAX COURT REPORT (304)
which the parties agree that that is in fact the case. 20 In
particular, petitioner points to the parties’ stipulation that
the windfall tax formula (for companies with a full 1,461-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 = 23% × [{(365 × (P/1,461)) × 9} – FV]
Windfall Tax Formula—Modification (1)
Tax = 23% × [{(P/4 [21]) × 9} – FV)]
Windfall Tax Formula—Modification (2)
Tax = 51.71% × {P – (44.47% × FV)} [22]
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 1, year 2, etc.).
Tax = 51.71% × {P1 – (11.11% × FV)}
+ 51.71% × {P2 – (11.11% × FV)}
+ 51.71% × {P3 – (11.11% × FV)}
+ 51.71% × {P4 – (11.14% × FV)} [23]
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 51.71-percent
rate ‘‘on the profits for each Windfall Tax company’s initial
period to the extent those profits exceeded an average annual
20 Respondent objects to certain of those stipulations on the ground that the reformulations
are neither (1) ‘‘the statutory equivalent of the equation set forth in the [Windfall Tax] Act’’ nor
(2) ‘‘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.
21 For the sake of simplicity here and in modification (2), 1,461 days divided by 365 days is
deemed to equal 4 rather than the more accurate 4.0027397.
22 Again, for the sake of simplicity, 44.47 percent represents (1,461/365)/9 or approximately
0.4447489 (which is approximately 4/9), and the 51.71 percent represents {9/(1,461/365)} × 23
percent or approximately 0.5171458 (which is approximately 9/4 of the 23-percent windfall tax
rate). As Professor Myers points out, to get from modification (1) to modification (2), one need
only multiply all terms inside the brackets (in modification (1)) by 4/9 and the 23 percent tax
rate by 9/4 with the windfall tax amount remaining unchanged, because (4/9) × (9/4) = 1.
23 The 11.14 percent reflects the multiplier for the leap year of 366 days, assumed, for demon-
strative purposes, to be year 4.
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(304) PPL CORP. & SUBS. v. COMMISSIONER 329
return of approximately 11.1 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 5 of the 32 windfall tax companies had ini-
tial periods longer or shorter than 1,461 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 1,461 days, the rate of the
reformulated windfall tax was very close to 51.71 percent,
and the 4-year return on flotation value to be exceeded for
there to be a tax was very close to 44.47 percent. For NIE,
which had an initial period of 1,380 days, those two rates
were 54.75 percent and 42.01 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 316 days, with
the result that the effective tax rate on its excess profits
(determined pursuant to the stipulated reformulation of the
tax) was 239.10 percent, and the cumulative 4-year return on
flotation value to be exceeded for there to be a tax was only
9.62 percent. Petitioner dismisses any concerns regarding the
effect of the reformulated windfall tax on those 5 companies
as compared to its uniform effect on the other 27 companies
on several grounds: (1) For 2 of the companies, the dif-
ferences are negligible; (2) any differences in effective rates
‘‘are not significant or material in evaluating the overall
incidence of the Windfall Tax’’ because the 5 companies are
outliers and, therefore, must be ignored for purposes of deter-
mining creditability under the section 901 regulations as
applied by the Court of Appeals for the Second Circuit in
Texasgulf II and this Court in Texasgulf I; (3) as Mr.
Osborne explained, the payment of relatively large amounts
of windfall tax by companies with initial periods of substan-
tially less than 1,461 days (i.e., NIE and Railtrack) was not
a problem because profits earned over the balance of what
would have been a full 1,461-day period (referred to by Mr.
Osborne as ‘‘out performance’’) would not be subject to the
tax; and (4) the tax did not exceed the realized, after-tax
profits of any of the windfall tax companies.
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330 135 UNITED STATES TAX COURT REPORT (304)
2. Respondent’s Arguments
Respondent argues that the 1983 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’’;
i.e., 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
1983 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 Exxon Corp. v. Commissioner, 113 T.C.
338 (1999), which did admit extrinsic evidence to dem-
onstrate the creditability of foreign taxes, should be limited
to their facts; i.e., 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 section 1.901–2(b)(4)(i)(B),
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
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(304) PPL CORP. & SUBS. v. COMMISSIONER 331
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. 24
Because for respondent ‘‘the ‘substance’ of the tax is
revealed on the face of the Windfall Tax statute itself ’’—i.e.,
‘‘[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 (i.e., 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
2000 book describing his life as a member of the Labour
Party, entitled ‘‘The Unconventional Minister’’, and quotes
the following portion of chapter 6, which describes the
development and enactment of the windfall tax:
Then in October 1996 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
24 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 section 901 regulations.’’
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332 135 UNITED STATES TAX COURT REPORT (304)
(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.’’ 25
25 Relying on a point that the Andersen team made in a November 1996 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 3 of this report); i.e., 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 1983 regulations, it is noncred-
itable. We find respondent’s arguments unpersuasive for two reasons. First, respondent’s own
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(304) PPL CORP. & SUBS. v. COMMISSIONER 333
C. Analysis
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 section 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
section 1.901–2(a), 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 ‘‘Profit-Making Value’’. It 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.’’ 26
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
1983 regulations: Exxon Corp. v. Commissioner, 113 T.C. 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 23 percent instead
[of the 33 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 section 171
TCGA and section 179 TCGA is substantively similar to the gain deferral and recognition rules
relating to intercompany transfers in our consolidated return regulations, section 1.1502–13, In-
come Tax Regs.’’ Petitioner argues, however, that ‘‘[t]he Windfall Tax statute was not designed
on the basis of Section 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.
26 ‘‘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 BedRoc Ltd., LLC v. United States, 541 U.S.
176, 183 (2004) (quoting Conn. Natl. Bank v. Germain, 503 U.S. 249, 253–254 (1992))). 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 Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 6
(2000) (quoting United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989)).
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334 135 UNITED STATES TAX COURT REPORT (304)
(1999), Texasgulf I, and Phillips Petroleum Co. v. Commis-
sioner, 104 T.C. 256 (1995).
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 section 901.
2. Nature of the Predominant Character Standard
Respondent’s text-bound approach to determining the cred-
itability of the windfall tax is inconsistent with the 1983
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(a)(3)(i), 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
1983 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 1983 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: Inland Steel Co. v. United States, 230 Ct. Cl. 314,
677 F.2d 72 (1982), and Bank of America I (see supra p. 321
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 at 325, 677 F.2d at 80 (emphasis added). The court
noted that the issue, as framed under its analysis in Bank
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(304) PPL CORP. & SUBS. v. COMMISSIONER 335
of America I, is ‘‘whether taxation of net gain is the ultimate
objective or effect of * * * [the foreign] tax.’’ Id. at 326, 677
F.2d at 80 (emphasis added). In Bank of America I, 198 Ct.
Cl. at 274, 459 F.2d at 519 (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 (e.g., sections 871
and 1441), the court concluded that an income tax under sec-
tion 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. at 281, 459 F.2d at 523. 27
Because the gross income taxes in Bank of America I failed
to meet that test, the court held that they were noncred-
itable. Id. at 283, 459 F.2d at 524–525.
Also, as noted supra, the cases that have applied the 1983
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
27 As noted supra note 12, the Court of Claims’ test for the creditability of a gross income tax
is incorporated into the 1983 regulations. See sec. 1.901–2(b)(4)(i), Income Tax Regs.
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336 135 UNITED STATES TAX COURT REPORT (304)
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 section 1.901–2(b)(4), Income Tax Regs., is a change
from the history and purpose approach used in the cases
decided before the 1983 regulations applied a factual, quan-
titative approach.’’ Texasgulf I, 107 T.C. at 70 (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 * * * [section
1.901–2(b)(4)(i)(B), 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 section 1.901–2(b)(4)(i), 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 section 1.901–2(b)(4)(i), 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
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(304) PPL CORP. & SUBS. v. COMMISSIONER 337
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, 172 F.3d at 216 n.11:
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) 28 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.
3. 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 1900 (4th ed.
2000). 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 is
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(f), repealed in 1990
by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101–508, sec. 11801(a)(3), 104 Stat.
1388–520. Moreover, differences between book and taxable income are, with rare exception, at-
tributable to timing differences, which are generally disregarded under the 1983 regulations.
See sec. 1.901–2(b)(4)(i), Income Tax Regs.
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338 135 UNITED STATES TAX COURT REPORT (304)
not ‘‘a real economic value’’. 29 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 31 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; i.e., 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 (i.e., ‘‘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 July 2, 1997,
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: (1) It would
recoup excessive profits earned by the privatized utilities
during the initial period, and (2) 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 1997 publication entitled ‘‘Explanatory
Notes: Summer Finance Bill 1997’’:
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.
29 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.’’
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(304) PPL CORP. & SUBS. v. COMMISSIONER 339
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. 30 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, 198 Ct. Cl. at 274, 459 F.2d at 519, 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. 31 And that is what we conclude in the
30 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. * * *
31 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 7 (Colum-
bia University Press 1921).
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 (1) the market value of rights exercised in consumption and (2) 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 50 (1938). 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 97 (6th ed. 2009).
A foreign tax imposed on a base conforming to the Haig-Simons definition of income, viz, (1)
the value of savings at the end of the period plus consumption during the period minus (2) the
value of savings at the beginning of the period, would seem to qualify as a tax on net gain under
Continued
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340 135 UNITED STATES TAX COURT REPORT (304)
case of the windfall tax. The architects and drafters of the
tax knew (1) exactly which companies the tax would target,
(2) the publicly reported after-tax financial profits of those
companies, which were a crucial component of the tax
base, 32 and (3) the target amount of revenue the tax would
raise. Therefore, it cannot have been an unintentional or
fortuitous result that, (1) for 29 of the 31 windfall tax compa-
nies that paid tax, the effective rate of tax on deemed annual
excess profits was at or near 51.7 percent, 33 and (2) for none
of the 31 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. 34 The design of
the windfall tax formula made certain that the tax would, in
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