Supreme Court decision could be a game changer for countries considering fundamental business tax reforms

Rice University
Office of Public Affairs / News & Media Relations


David Ruth

Amy Hodges

Supreme Court decision could be a game changer for countries considering fundamental business tax reforms

HOUSTON – (Nov. 3, 2014) – A tax charged to certain U.S. companies doing business in the United Kingdom now qualifies for the U.S. foreign tax credit, according to a recent unanimous decision by the U.S. Supreme Court. The decision could have far-reaching implications for the creditability of taxes not ordinarily considered income taxes and thus for countries considering replacing their traditional business income taxes with alternative “cash flow” or “consumption-based” business taxes, according to new research from Rice University.

The study appeared recently in the journal International Tax and Public Finance. It examines the tax policy implications of a ruling by the U.S. Supreme Court regarding a one-time retroactive British “windfall tax” levied on 32 public utilities that were privatized between 1984 and 1996.

The ruling states that eligibility for the U.S. foreign tax credit (FTC) should be governed by the economic substance of the tax rather than by its legislative form as was argued by the U.S. Internal Revenue Service. The court’s decision means that the companies are now eligible for the FTC for their tax payments under the U.K.’s windfall tax and thus will not be subject to double taxation in the U.K. and the U.S. on their income.

George Zodrow, the Cline Professor of Economics at Rice and one of the study’s authors, said that the decision may have important implications for determining which taxes will be eligible for the FTC, which grants U.S. multinational corporations credits against their domestic tax liability for certain taxes paid to foreign governments.

“The Supreme Court’s decision establishes that the economic substance of a tax, rather than the wording in the legislative description of the tax, should be the deciding factor when determining eligibility for the FTC,” Zodrow said.

The authors of the study and five other prominent economists, including Rice Economics Professor Malcolm Gillis, argued in an amici curiae brief presented to the court that even though the U.K. tax was called a tax on “excess value,” its actual design features implied that it was in fact a tax on excess profits and thus should be creditable under current law — an argument accepted unanimously by the court.

Zodrow said that the decision could have significant tax policy repercussions far beyond this particular case, as the logic underlying the court’s decision may be extended to imply that other taxes formerly thought to be noncreditable may qualify for FTCs.

“Many countries, including several in Latin America and in Europe, have expressed considerable interest in replacing their traditional income taxes with cash flow or consumption-based taxes on the grounds that such tax systems are more conducive to saving, investment and growth, are fairer and are easier to administer,” Zodrow said. Examples of such cash flow taxes include the flat tax and the progressive consumption tax discussed in the 2005 report of the President’s Advisory Panel on Federal Tax Reform.

“In the past, these countries ultimately decided against enacting such business taxes out of concern that the IRS would deem the taxes to be not creditable because they differ in form in several ways from traditional income taxes,” Zodrow said. “However, because the economic substance of these cash flow taxes is quite similar to numerous income taxes that have been deemed creditable, the precedent established by this recent Supreme Court ruling may imply that these taxes will also be deemed creditable — a development that would eliminate an important impediment to the enactment abroad of such fundamental business tax reforms.”

The study, “U.S. Supreme Court Unanimously Chooses Substance Over Form in Foreign Tax Credit Case: Implications of the PPL Decision for the Creditability of Cash-flow Taxes,” was co-authored by Charles McLure Jr., senior fellow emeritus at the Hoover Institution at Stanford University, and Jack Mintz, the Palmer Chair at the University of Calgary’s School of Public Policy. The paper is available online at


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About Amy McCaig

Amy is a senior media relations specialist in Rice University's Office of Public Affairs.