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July 15, 2012 The Tax Lawyer

Hybrid Taxation: The Dual Function and Creditability of the U.K. Windfall Tax

Vol. 65, No. 2 - Winter 2012

Kirsten S. Linder


    Starting in the 1970s, the United Kingdom embarked on an extensive plan to privatize a large number of government-owned companies. As part of this process, the U.K. government privatized ownership of public utilities between 1984 and 1990. The Windfall Companies were offered on the London Stock Exchange for a fixed flotation value set by the government. After privatization, the Government regulated the companies by setting price caps, which were adjusted only once each year. This regulatory system was chosen to provide incentive for companies to find efficiencies while protecting consumers by constraining the prices the Windfall Companies could charge. However, in the period following privatization, the utility companies achieved massive unexpected efficiencies. Because the price cap was adjusted only once each year, the companies were able to accrue huge profits, issue large dividends, and pay extravagant compensation to directors and executives. Consequently, these companies garnered significant criticism from the public and the press. Critics also asserted that the government had significantly undervalued the companies’ flotation values, and therefore the companies’ profits were undeserved gains.

    The Labour Party had been opposed to privatization throughout the 1980s, and as early as 1992, the Party started to promote the idea of a tax on the windfall gained by the privatized companies. The Labour Party was voted into Parliament in 1997, and the U.K. Windfall Tax was enacted in July of that year.

    PPL and Entergy, two American power companies with U.K. subsidiaries sought a foreign tax credit under section 901 12 with respect to Windfall Tax payments for taxable year 1997. In PPL v. Commissioner and Entergy v. Commissioner , the Tax Court considered the creditability of the Windfall Tax. In determining whether the tax is creditable under section 901, the Windfall Tax presents an extremely close case because it can be construed convincingly as a tax on the value of the companies, in which case it is not creditable, or on the companies’ profits, in which case it is creditable. The Tax Court held that the tax was creditable because it operated as an excess profits tax. The Service appealed. In late December 2011, the Third Circuit reversed in PPL v. Commissioner and held that the Windfall Tax was not creditable.

    This Note argues that the tax should be creditable because it is a hybrid tax, functioning both as an adjustment to value and as an excess profits tax and because the credit’s pro-investment purpose tips the balance in favor of creditability.

    Part II of this Note examines the history and relevant areas of law surrounding the Windfall Tax and the foreign tax credit. Part III provides an overview of the PPL case. Part IV analyzes the Windfall Tax according to the regulations and examines the form, purpose, and operation of the tax to demonstrate that the Windfall Tax is a hybrid tax aimed at both value and excess profits. Part V proposes a tiebreaker rule for hybrid taxes and argues that creditability is warranted here because it would further the pro-investment aim of section 901.

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