PPL Corp. v. Comm'r of Internal Revenue
| Decision Date | 09 September 2010 |
| Docket Number | No. 25393–07.,25393–07. |
| Citation | 135 T.C. No. 15,135 T.C. 304 |
| Parties | PPL CORPORATION & Subsidiaries, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Held: The United Kingdom windfall tax enacted on July 2, 1997, and imposed on certain British utilities is a creditable tax under sec. 901, I.R.C.
Richard E. May, Mark B. Bierbower, and Timothy L. Jacobs, for petitioner.
Melissa D. Arndt, Allan E. Lang, Michael C. Prindible, and R. Scott Shieldes, for respondent.
PPL Corp. (petitioner) is the common parent of an affiliated group of corporations (the group) making a consolidated return of income. By notice of deficiency, respondent determined a deficiency of $10,196,874 in the group's Federal income tax for its 1997 taxable (calendar) year and also denied a claim for refund of $786,804. The issues for decision are whether respondent properly (1) denied the claim for the refund, which is related to the creditability of the United Kingdom (U.K.) windfall tax paid by petitioner's indirect U.K. subsidiary (the windfall tax issue), (2) included as dividend income a distribution that petitioner received from the same indirect U.K. subsidiary, but which, within a few days, the subsidiary rescinded and petitioner repaid (the dividend rescission issue), and (3) denied depreciation deductions that petitioner's U.S. subsidiary claimed for street and area lighting assets. We disposed of the third issue in a previous report, PPL Corp. & Subs. v. Commissioner, 135 T.C. ––––, (2010), and we dispose of the remaining issues here.
Unless otherwise stated, all section references are to the Internal Revenue Code in effect for 1997, and all Rule references are to the Tax Court Rules of Practice and Procedure. With respect to the two issues before us here, petitioner bears the burden of proof. See Rule 142(a).1
The parties have entered into a first, second, and third stipulation of facts. The facts stipulated are so found. The stipulations, with accompanying exhibits, are incorporated herein by this reference.
Petitioner is a Pennsylvania corporation that was known during 1997 as PP & L Resources, Inc. It is a global energy company. Through its subsidiaries, it produces electricity, sells wholesale and retail electricity, and delivers electricity to customers. It provides energy services in the United States (in the Mid–Atlantic and the Northeast) and in the United Kingdom. During 1997, South Western Electricity plc (SWEB), a U.K. private limited liability company, was petitioner's indirect subsidiary.2 Its principal activities at the time included the distribution of electricity. It delivered electricity to approximately 1.5 million customers in its 5,560–square–mile service area from Bristol and Bath to Land's End in Cornwall. SWEB also owned electricity-generating assets.
The Conservative Party won control of the U.K. Parliament in the 1979 elections. It retained control through May 1997, under the leadership of Margaret Thatcher and John Major.
Between 1979 and 1983, the Conservatives privatized mostly companies that were not monopolies (e.g., manufacturing companies) and, for that reason, did not require specific economic regulation. Between 1984 and 1996, however, the U.K. Government privatized more than 50 Government-owned companies, many of which were monopolies.
The U.K. Government privatized those companies largely through public flotations (share offerings) at fixed price offers, which involved the transfer of those Government-owned enterprises to new public limited companies (plcs), followed by what was essentially a sale of all or some of the shares in the new plcs to the public.3 The plcs then became publicly traded companies listed on the London Stock Exchange. In most cases, the floated shares opened for trading at a substantial premium over the price the flotation investors paid for the shares.
In December 1990, the U.K. Government privatized 12 regional electric companies (RECs), including SWEB. The ordinary shares of each REC were offered to the public at £2.40 per share in connection with the flotation of those shares.
The 32 U.K. Government-owned companies that were privatized and that ultimately became liable for the windfall tax (the privatized utilities or windfall tax companies) and the years in which they were privatized are as follows:
+-----------------------------------------------------------------------------+
¦Year ¦Company ¦
+------+----------------------------------------------------------------------¦
¦1984 ¦50.2 percent of British Telecommunications plc (British Telecom) ¦
+------+----------------------------------------------------------------------¦
¦1986 ¦British Gas plc ¦
+------+----------------------------------------------------------------------¦
¦1987 ¦British Airports Authority ¦
+------+----------------------------------------------------------------------¦
¦1989 ¦10 water and sewerage companies (the WASCs) ¦
+------+----------------------------------------------------------------------¦
¦1990 ¦The 12 RECs ¦
+------+----------------------------------------------------------------------¦
¦1991 ¦60 percent of National Power plc and Powergen plc (the generating ¦
¦ ¦companies) ¦
+------+----------------------------------------------------------------------¦
¦1991 ¦Scottish Power plc and Scottish Hydro–Electric plc (the Scottish ¦
¦ ¦electricity companies) ¦
+------+----------------------------------------------------------------------¦
¦1993 ¦Northern Ireland Electricity (NIE) ¦
+------+----------------------------------------------------------------------¦
¦1996 ¦Railtrack plc (Railtrack) ¦
+------+----------------------------------------------------------------------¦
¦1996 ¦88.5 percent of British Energy plc (British Energy) (which owned U.K. ¦
¦ ¦nuclear generating stations) ¦
+-----------------------------------------------------------------------------+
Regulation of the Windfall Tax Companies
The Electricity Act of 1989, c. 29, sec. 1, created the position of U.K. Director General of Electricity Supply, a position that Professor Stephen C. Littlechild (Professor Littlechild) held from its creation in 1989 through 1998.4
Before that appointment, in 1983, the U.K. Secretary of State asked Professor Littlechild for his advice on how to regulate British Telecom in the light of its impending privatization. Professor Littlechild recommended a regulatory scheme which regulated prices rather than, as in the United States, maximum profits or rates of return. The premise of the scheme, which became known as “RPI–X”,5 was that, if the Government fixed prices (but not profits) for a set number of years, the privatized companies would have an incentive to reduce costs to maximize profits during that period. Prices would be reset (presumably downward) at the start of the next regulatory period, to garner for consumers the fruits of the prior period's cost reductions. Profits might in a sense become excessive during any regulatory period (because a company achieved greaterthan-anticipated savings and there was no mechanism for mid-period correction), but balance would be reestablished at the start of the next period. The goal was to increase efficiency, encourage competition, and protect consumers. Under RPI–X, prices were not allowed to increase during the regulatory period, except to allow for inflation (i.e., increases in RPI) less an amount (the X factor, which did not vary during the period) intended to reflect expected, increasing efficiency.
The U.K. Government set the X factors for the first regulatory periods, just before the initial privatization, to be effective for what was, in most cases, the 5–year period after privatization. Industry regulators subsequently reset the X factors, typically every 4 or 5 years. In some cases, particularly where investment requirements were high (e.g., in the case of companies that had underinvested while under public ownership), the X factor might be positive (RPI + X). That was the case for most of the RECs and WASCs.
Each of the regulatory bodies for the privatized utilities followed the RPI - X regulatory method, which was adopted for 29 of the 32 windfall tax companies, the exceptions being the generating companies. On March 31, 1990, the RPI - X methodology as applied to the RECs came into effect for the 5–year period ending March 31, 1995. As noted supra, because the RECs were in need of large capital expenditures during the initial 5–year period, the U.K. Government set price controls for the RECs in the form of RPI + X; i.e., it provided for annual increases in electricity distribution charges above the rate of inflation rather than reductions in those charges.
During the initial postprivatization period (the initial 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. That ability led to higher-than-anticipated profits, 6 which, in turn, led to higher-than-anticipated dividends and share price increases for the privatized utilities. The large profits, dividends, and share price increases resulted in sharply increased compensation for utility directors...
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