U.K. Excess Profits Tax Under U.S. Foreign Tax Credit

Corporate Taxation

Between 1984 and 1996, the government of the United Kingdom, under the control of the Conservative Party, privatized ownership of more than 50 state-owned companies by making public offerings of their stock. In December 1990, the government privatized twelve regional electric companies but immediately regulated the prices that the privatized utilities could charge the public.

During the post-privatization period, the privatized utilities were able to increase efficiency and reduce operating costs to a greater degree than had been expected when the initial price controls were established, and accordingly the privatized utilities generated much higher profits than had been anticipated. The public came to believe that the utilities had been sold too cheaply and that their profits were excessive in relation to the price that had been paid for their stock. In the elections of 1996, the Labour Party promised to impose a special tax on the privatized utilities if it was elected to replace the Conservative Party government.

The Labour Party won the election and, as part of the Finance Act of 1997, enacted an "Excess Profits Tax" to recover the "windfall" profits of certain companies that had been privatized in the 1980s and 1990s, including the regional electric companies. For political and administrative reasons the Excess Profits Tax was not implemented as a straightforward tax on the "undeserved" profits of the privatized companies; rather, the tax was levied at the rate of 23% on the excess of (i) each company's estimated fair market value; over (ii) the price at which it had been sold by the Conservative government. The estimated fair market value of each company was set by a formula that capitalized (using a nine times earnings multiple) the company's earnings over its first four years as a private concern.

U.S. taxpayers owned three of the U.K. companies subject to the Excess Profits Tax and, after their U.K. subsidiaries paid the tax to the United Kingdom, the U.S. parents claimed foreign tax credits for the tax on their U.S. federal income tax returns. The parents' claims have reignited arguments long thought to be settled and generated a conflict in the circuits that is now on its way to the U.S. Supreme Court.

This article was written by Stafford Smiley and Michael Lloyd. Stafford Smiley is Professor, Graduate Tax Program, at the Georgetown University Law Center. Michael Lloyd is an associate with, and Professor Smiley is a Senior Counsel to, the law firm of Caplin & Drysdale, Chartered, Washington, D.C.

This article was published in the January/February issue of Corporate Taxation, © 2013 Thomson Reuters/WG&L.

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