When is a foreign tax creditable under sec. 901?

The Supreme Court has granted certiorari in a Third Circuit case to resolve a circuit split and to answer the question of when a foreign tax is creditable under Sec. 901.

Background

Under Sec. 901(b)(1), taxpayers can claim a credit for "the amount of any income, war profits, and excess profits taxes paid or accrued ... to any foreign country." This provision was enacted in 1918, and, ever since, the meaning of the word "income" in the provision has been the subject of "long and tortuous" litigation (Bank of Am. Nat'l Trust & Say. Ass'n, 61 T.C. 752, 759 (1974)).

Regs. Sec. 1.901-2(a)(1) combines the statutory terms, "income, war profits, and excess profits tax," into one concept: income tax. A foreign assessment is an income tax if it has the "predominant character ... of an income tax in the U.S. sense" (Regs. Sec. 1.901-2(a)(1)(ii)).

A foreign assessment has the predominant character of a tax if it is "likely to reach net gain in the normal circumstances in which it applies," but is not a "soak-up" tax that is applied only if a foreign tax credit is available (Regs. Secs. 1.901-2(a)(3)(i) and (c)(1)). An assessment is "likely to reach net gain" if it meets three requirements: the realization, gross receipts, and net income requirements (Regs. Sec. 1.901-2(b)(1)). The realization requirement--a timing requirement--ensures the taxpayer has received income before being obligated to pay taxes on it. The gross receipts and net income requirements concern the tax base, i.e., the amount on which the tax is levied.

Circuit Split

In PPL Corp., the case in which the Supreme Court granted certiorari, the Third Circuit employed a mechanical test for determining whether a foreign assessment meets the regulations' requirements to qualify as a creditable tax. The case involved the 1997 U.K. windfall profits tax on utilities that were privatized and price regulated. After privatization, the utilities' profits were much higher than had been expected, so the British government imposed a one-time windfall profits tax.

The Third Circuit held that PPL Corp. was not eligible to claim a foreign tax credit for its payment of the windfall profits tax because the tax did not meet the gross receipts requirement of Regs. Sec. 1.901-2(b) (1). Under this subsection, a tax is creditable if, judging by its predominant character, it is imposed on the basis of gross receipts or gross receipts computed under a method that is likely to produce an amount that is not greater...