On May 20, 2013, the Supreme Court of the United States decided PPL Corporation and Subsidiaries v. Commissioner, 569 U.S. __ (2013). This was the Court’s first tax decision of the 2012 Term. It issued five tax decisions in its 2011 Term. This decision ruled for the taxpayer.

It involved a foreign tax credit’s creditability as a tax on net income. The case was not a “tax shelter case” and arose only because the IRS challenged the taxpayer’s reasonable claim of credit for the UK Windfall Tax of 1997. The facts are complex and unlikely to be repeated in an analogous case, but the grounds of the ruling are important and could be useful to taxpayers in future foreign tax credit cases.

In effect, the Court ruled that any foreign tax that is computed under a formula that utilizes net income as a variable (better yet if it is the only variable) is an income tax for credit purposes. Readers will recognize that this can convert any property tax based on valuing a business through a multiple of earnings into an income tax. In fact, that is exactly what the Court ruled in PPL.

The tax at issue was a one-time British Windfall Tax, which was expected to fall indirectly on many large and influential U.S. corporations. The former Arthur Andersen accounting firm advised the British government on the design of the tax. It is entirely possible that the advisor foresaw, if not intended, that the design of the formula using the net income could pave the way for the U.S. foreign tax credit—and it did.

This is all to the good for U.S. taxpayers who have the ability to influence the design of foreign taxes, or to take advantage of the odd foreign tax as a credit. However, it could have unexpected consequences for tax protesters who like to object to novel taxes as unconstitutional, unapportioned direct taxes on property. See Cummings, The Supreme Court, Federal Taxation and the Constitution, Ch. V.C. (ABA Books 2013). The PPL opinion broadens the scope of income taxes and can be cited against such complaints in the future.

New Companion to the 338(h)(10) Election

The Treasury has finalized the regulations under Section 336(e) proposed in 2008. These regulations allow a domestic seller of stock to elect in certain cases to disregard its sale of at least 80 percent of the vote and value of a domestic target corporation and, rather, have the target taxed on the deemed sale of its assets, and then deemed to liquidate into the stock seller. This can produce a stepped-up basis in the assets of the target in the hands of the stock buyer and can do so at no added tax cost to the seller. The normal reason for such an election is to allow the stock seller to charge more for the target stock, since it can now deliver an inside asset basis step up.

The key points to remember are the conditions on the applicability of the election:

  • It applies to stock sales to which Section 338(h)(10) cannot apply because the purchaser of stock is not a single corporation or members of an affiliated corporate group.
  • Eighty percent of the vote and value of the stock of a target must be sold in a recognition event or a taxable stock distribution within a 12-month period.
  • The seller must be either a single domestic corporation or members of a consolidated group or S corporation shareholders and the target must be a domestic corporation, C or S.
  • The seller and the target must properly elect.

The election also can be made for a Section 355 distribution that becomes partly taxable under Section 355(d) or (e). In such cases, the distributing corporation and the controlled corporation should make a protective election, as such liability is not known until later. Also, if there is an internal spin within the group of the distributing corporation prior to the external spin, the special election does not prevent the taxation of the internal spin, although it will step up the basis of the assets inside the spun corporation.