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Updated February 22, 2008
Closing Corporate Tax Loopholes
Despite our state’s best efforts, corporate tax accountants
are increasingly finding ways to avoid paying Tennessee
business taxes.
One of the ways corporations do this is by sending or
“paying” their local profits to out-of-state
subsidiaries, located in states like Delaware and Nevada,
where there are limited or no corporate income taxes, for
the use of corporate logos and other property.
Taxing Multi-State Corporations:
Almost all states levy some kind of tax on the profits
and assets of businesses operating within their states as
these businesses use the roads, education system, police,
and courts just like everyone else. Tennessee levies both
a franchise tax on the book value of a company and an excise
tax on the company’s net profits.
When a business operates in more than one state, an apportionment
formula is used to measure how much of the company’s
overall economic activity takes place in the state, and
thus is taxable within that state. Tennessee uses a formula
based on assets, payroll, and sales made within Tennessee.
Understanding the Shell Game:
The most common vehicle for such tax avoidance schemes
are Passive Investment Corporations (PICs), also known as
Delaware or Nevada Holding Companies. These are subsidiaries
that “own” the corporate logos and other intellectual
property.
Toys-R-Us has such a subsidiary in Delaware known as Geoffrey.
So when Toys-R-Us turns a large profit in Tennessee, they
“pay” most of the profit to their Delaware PIC
for the rights to use the Toys-R-Us logo.
Using this tactic, their profits in Tennessee are reduced,
or even eliminated, for tax purposes. Instead, the profits
show up in Delaware, where conveniently, profits earned
from the sale of such intellectual property (logos, etc.)
are not taxed. Toys-R-Us wins. Tennessee loses.
The true irony of this is that the income is added back
together when it comes time to report to their corporate
share holders. That is, from a stockholder stand-point,
the income of the subsidiary and the parent company are
one in the same. They're just moving money from one hand
to the other.
How Widespread is the Practice?
In addition to Toys-R-Us, some of the other companies
that are known to use such PICs include Burger King, CompUSA,
Gap, Home Depot, Kmart, Kohl’s, Long John Silver’s,
Staples, Sherwin-Williams, and the Limited / Victoria’s
Secret to name a few.
This practice is becoming increasingly widespread, and
will result in the gradual erosion of Tennessee's tax base
if no action is taken. Below are just a few examples of
CPA firms advertising their ability to help corporations
avoid state taxes by setting up such PICs or Holding Companies:
One
law firm, Buchanan Ingersoll PC, provides an on-line primer on the legalities of setting up such PICs, and of course,
offers its services at the end of the primer, "The
tax attorneys at Buchanan Ingersoll PC are available to
assist you in assessing proposed structures and reviewing
existing Delaware holding company strategies."
In fact, according to Entity
Services Group, there are an estimated 7,000 such PICs
or Holding Companies incorporated in Delaware alone.
Ending the Shell Game:
The good news is that one simple rewrite of corporate
tax law would close all these loopholes at once. Complete
reporting, also known as combined reporting, would require
corporations to combine all of their subsidiaries and related
companies into one company for tax purposes, putting an
end to the ability to shuffle money from one hand to the
other in order to avoid state taxes.
Twenty-one states have already enacted this type of complete
reporting, including most recently New York, Texas, West
Virginia, Vermont, and Michigan.
Tennessee has a combined or complete reporting statute
on the books, but it is not mandatory and is applied to
companies only at the discretion of the Commissioner of
Revenue. In practice, it is rarely if ever applied to corporations
operating in Tennessee outside of the banking industry.
TFT's proposed reform would make it mandatory for all multi-state
corporations as it is in twenty-one other states.
Getting accurate estimates for how much such a reform
would generate is difficult because the existence of such
PICs is considered “proprietary” information
that businesses are reluctant to disclose. However, based
on available data, such a reform in Tennessee could raise
enough to pay for another 2 percent food tax cut.
See
"Growing Number of States Considering a Key Corporate
Tax Reform," by Michael Mazerov of the Center on Budget
and Policy Priorities to learn more.
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