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US States Move To Close 'Abusive' Corporate Tax Strategies

by Leroy Baker, Tax-News.com, New York

09 April 2007


Governors in six states have recommended that their state adopt a key reform to outlaw a variety of 'abusive' income-tax-avoidance strategies practiced by large corporations, a new report by the Center on Budget and Policy Priorities has shown.

According to the report by the nonpartisan research organization and policy institute, eighteen states had already adopted the reform, known as “combined reporting,” as of the start of 2007. In recent weeks, the governors of Iowa, Massachusetts, Michigan, New York, North Carolina, and Pennsylvania all proposed the reform as part of their new budgets.

New York’s legislature approved this proposal on April 1, while on March 10, West Virginia’s legislature enacted a combined reporting bill that was not initiated by the governor, but which he is expected to sign.

“Six governors decided this year, independently of one another, that it’s time to make their corporate tax systems fairer and stronger by adopting this reform,” said Michael Mazerov, a senior fellow at the Center and the report’s author. “Tax experts have long urged states to take this step, and this year a growing number of states are listening.”

The Center's study reported that, to avoid state corporate income taxes, a number of large, multistate corporations have devised strategies to move profits out of the states in which they are earned and into states in which they will be taxed at lower rates - or not at all. They do this by creating subsidiaries largely or solely as tax shelters in “tax haven” states like Delaware and then artificially shifting funds to them in the form of royalties or rent.

The report cited as an example the case of retailer Wal-Mart, which has transferred ownership of all of its stores to a Wal-Mart subsidiary. In most states, this enables Wal-Mart to deduct the “rent” it pays the subsidiary (i.e., the rent it pays itself) from the income that is subject to state corporate taxes. The subsidiary receiving the rent isn’t taxed because it qualifies as a tax-exempt Real Estate Investment Trust under federal and state law.

The Center argues that this practice is wrong because it costs states billions of dollars in revenue, forcing individuals and small businesses which lack the resources to exploit the loophole to pay higher taxes than would otherwise be necessary. They also give multistate corporations an unfair tax advantage over in-state corporations and smaller businesses, the Center said.

Combined reporting is considered to create a level playing field for all businesses by treating a parent corporation and most of its subsidiaries as a single corporation for income tax purposes; the state taxes a share of the entities’ combined nationwide income, depending on how much of the corporation’s total activity takes place in that state.

The report noted that sixteen states have mandated and successfully used combined reporting for decades, but this group has only recently begun to expand, even after the US Supreme Court ruled in 1983 that combined reporting was both fair and constitutional.

In 2004-05, Vermont became the first state in more than 20 years to adopt combined reporting and Texas included combined reporting in a new business tax it enacted. West Virginia and New York have adopted the reform in just the past few weeks. And Governor Michael Easley of North Carolina, Governor Chet Culver of Iowa, Governor Jennifer Granholm of Michigan, Governor Deval Patrick of Massachusetts, and Governor Edward Rendell of Pennsylvania have all recommended combined reporting as part of their current tax and budget packages.

“Combined reporting can bring in revenue to help a state finance essential public services like education and health care,” said Mazerov. “Closing major corporate tax loopholes through combined reporting will make a state’s tax system fairer to state residents and businesses, as well as stronger over the long term.”


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