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Argument recap: The Court does algebra, and hilarity ensues

Yesterday, the Court heard arguments in PPL Corp. and Subsidiaries v. Commissioner, which examines the issue of how the US tax system should treat taxes paid to foreign governments. My argument preview, which outlines the issues and the parties’ arguments, may be found here. The tax in question is the U.K. windfall tax of 1997, which was imposed on a number of U.K. energy companies that had been privatized under Margaret Thatcher and later became subject to public scrutiny because the companies subsequently reaped excessive profits.

The case arises because the windfall tax is calculated using a formula that renders the target of the tax ambiguous: it could either be the profits earned by the companies over a specific period after they were privatized (in which case it is an income tax for U.S. purposes), or it could be a means of making up for an undervaluation in the sale price when the companies were privatized (in which case it would be a tax on value). If the Court decides that the U.K. windfall tax was an income tax for U.S. purposes, it is creditable against PPL’s U.S. income tax liability.

Paul D. Clement of Bancroft PLLC argued on behalf of PPL Corp; Ann O’Connell, Assistant to the Solicitor General, argued for the government. Mr. Clement argued that the technical language of the U.K. windfall tax could and should be reformulated to show that in substance it was an income tax, imposed retroactively on profits earned over a prescribed period. Ms. O’Connell argued that both the form and the substance of the windfall tax were in the nature of a retroactive tax on value, meant to extract more sales proceeds for the government when it was decided that the initial price had been too low.

PPL’s argument

Mr. Clement opened his argument by recounting the U.K. Parliament’s enactment of the windfall tax. He focused on the fixed price regime that had been imposed on the companies in connection with the privatization, and cast the windfall tax as a retroactive imposition of higher taxes on the generous profits companies had realized despite the pricing limits.

Mr. Clement was quickly interrupted by Justice Sotomayor, who took issue with his assumption that this was the only way of looking at the windfall tax.  Instead, the Justice said, the windfall tax could have been either on excess profits or the undervalued flotation price, and a re-valuation of that price would itself be calculated by reference to profits in any event. Justice Sotomayor did not appear sympathetic to PPL’s position. She exchanged a number of interruptions with Mr. Clement, at one point claimed that he was undermining his own argument, and twice asked if he wasn’t simply seeking a decision that any tax based in any manner on profits must be a tax on income and therefore eligible for the foreign tax credit.

Mr. Clement argued that there was no slippery slope here, under which a win for his client would mean that, in effect, any tax based in any measure on profits would be deemed an income tax eligible for the credit. However, he argued that if a tax were based on value, and that value was defined mainly by reference to profits, the tax would meet the test of predominant character set forth in the regulations. Mr. Clement repeatedly relied on the “outlier” argument set forth in PPL’s brief and those of its supporting amici – namely, that the fact that the tax doesn’t appear to act like a tax on income for at least one of the affected companies should be ignored because the situation is an anomaly. Justice Kagan disagreed with this view and thought that the outlier was a specific target of the tax.

Justices Sotomayor and Kagan engaged Mr. Clement at length on the algebraic reformulation of the windfall tax, which will likely be central to the decision in this case. Justice Sotomayor took issue with PPL’s position, viewing it as a glossing over of the time variable in the statutory formula; Justice Kagan tried to unravel the various possible algebraic reformulations and what the Court ought to make of them. Several Justices and at one point Mr. Clement appeared to become confused in this discussion. Justice Kennedy intervened briefly during the exchange to ask what the Court should do if it thought the windfall tax was both a tax on profits and a claw-back on an undervalued flotation price. Mr. Clement argued that in this particular case the Court would decide the tax was creditable because the value being measured here was solely determined by retrospective earnings over a four-year period.

Justice Kagan suggested that the windfall tax was in substance trying to get at value through profitability, not profits per se. If the Court decides against PPL Corp, this profitability/profits distinction may guide the discussion, as it allows the Court to explain why a foreign law that computes a tax under a formula that includes prior profits is not in substance a tax on those profits, counter to the PPL’s argument and the Tax Court decision.

Justice Ginsburg intervened with two brief questions.  First, she wondered if Mr. Clement knew of any instance in which a foreign tax credit was granted against a tax like the windfall tax in question – a one-time-only adjustment, operating retrospectively on earnings. Mr. Clement couldn’t put his finger on an example, but said it didn’t matter because factors like retroactivity and regularity are not dispositive for the determination. Later, in response to a question to Ms. O’Connell from Justice Breyer about whether the Tax Court ought to be given special deference on tax cases, Justice Ginsburg wondered whether the Commissioner ought to be given special deference since it was his regulation at issue. Ms. O’Connell answered both in the affirmative, but pointed out that the Tax Court did not analyze the windfall tax under the applicable test set forth in the regulation.

The Commissioner’s argument

Ms. O’Connell opened her argument by saying that profits are typically used in calculating a company value, but she was immediately interrupted by Justice Scalia, who disagreed with the claim. Justice Breyer quickly broke in and engaged with Ms. O’Connell at length on the valuation and algebraic reformulation questions. His focus was on the relevance of the numeral 9 in the statutory formula, which represented the lowest average price ratio of the privatized companies, and which Justice Breyer took to be an arbitrary number. After a lengthy and somewhat muddled discussion on what the formula intended to achieve, Ms. O’Connell concluded that the windfall tax calculated the proper price at which the U.K. government should have sold the companies when they were privatized, and then subtracted what the government actually received in the exchange.

This is a slightly different argument than has come before, and it suggests that the tax in question isn’t really a tax at all, but rather a purchase price adjustment. This would suggest that if the Court decides that the windfall tax is not an income tax, not only would it not be creditable, but it also would not be deductible: instead, it would be added to PPL’s basis in the company. This is in contrast to Ms. O’Connell’s statement that “the IRS has said throughout this case that it is perfectly happy to treat this windfall tax as a deduction.”  The parties stipulated in their briefs that the windfall tax is a tax.


On rebuttal, Mr. Clement returned to the question of what the U.K. statute meant when it used the term “value”. Justice Kagan pointed out that under Mr. Clement’s reasoning, the same tax, enacted two years earlier, would not have been a tax on income because it would exceed 100% of profits. Mr. Clement demurred, worked in a few more mathematical analyses of the formula, and concluded by reiterating his argument in favor of a “substance over form” approach.


From my reading of the transcript, the Chief Justice, who chimed in only briefly, appears to view the government’s position as an inappropriate attempt to extract tax on income that has already been taxed by the U.K., while Justices Sotomayor and Kagan appeared to reject PPL’s algebraic gymnastics and may be inclined to view the U.K. windfall tax as a claw back of the undervalued sale price and not a tax on income. Justice Breyer had a little fun with the algebra, but it is not clear how that will influence his legal analysis. After a particularly confusing exchange involving adjusted percentages, Justice Breyer said that his law clerks will have picked up on the issue and he would figure it out later. Having done all that math in their heads, no doubt the Justices will seek to place the algebraic gymnastics in a central role in the decision.

Mr. Clement’s claim that PPL Corp, the petitioner, is the only party appropriately using the “substance over form” approach appears to have been dispelled in oral argument. As a result, I do not think it will have been enough for PPL Corp to argue that the case is about an interpretive standard. Instead, it appears from the transcript that the Justices understand that both sides are asking it to consider the substance of the laws in question. The Court is thus likely to answer the Commissioner’s question instead – namely, whether the U.K. windfall tax is an income tax in the U.S. sense.



Recommended Citation: Allison Christians, Argument recap: The Court does algebra, and hilarity ensues, SCOTUSblog (Feb. 21, 2013, 6:10 PM),