The U.S. taxman should give credit where credit's due. American companies can typically subtract foreign levies from their income tax bill. But a hyper-technical decision by the Internal Revenue Service puts that rule, and investment abroad, at risk. The Supreme Court has a chance to make things right.
The justices will hear a tax dispute between the IRS and U.S. energy company PPL Corp. – a rare step for America's top court, which usually steers clear of such battles. PPL is contesting a decision that may cost it about $150-million (U.S.) in tax credits.
The company assumed it could claim a credit for the 1997 windfall assessment it paid on income from a British utility acquired seven years before. The IRS disagreed, claiming the charge wasn't a tax on the utility's income but on its value, which was merely measured by income.
The agency cited the arcane rules about applying foreign tax credits to back up its stance. If the "predominant character" of another nation's levy is an income tax "in the U.S. sense," the credit applies. That allows the IRS a slice of offshore revenue while saving companies from a double hit.
The logic of the agency's argument escaped many experts, including two U.S. courts, which stressed that oddly structured foreign levies are often income taxes in substance. But a federal appeals court backed the IRS last year.
If the Supreme Court rules in favour of the IRS, the potential impact on all U.S. companies operating abroad would be considerable. More than 7,200 U.S.-based firms claimed over $100-trillion of foreign tax credits in 2008, according to the most recently available IRS statistics. Disallowing even a small fraction of that amount would prompt years of litigation.
It would also inject new uncertainty into decisions to invest abroad. If U.S firms had to pay foreign and domestic taxes on the same income, they'd probably do a lot less business in other countries. And those countries would have to choose between encouraging American investment and raising revenue from income earned on their turf. Global economic growth could suffer.
The justices should make the most of this rare opportunity to tackle tax policy and remind federal pencil pushers that form doesn't trump substance.