January/February 2008

Corporate Tax Avoidance: Getting Big Biz to Pony Up Its Fair Share

"Aggressive tax avoidance by large, sophisticated multistate companies is a serious and growing problem. Unfortunately, Wisconsin remains something of a laggard among the states in addressing it."

This observation was made by Michael Mazerov, a senior fellow at the Center on Budget and Policy Priorities, in his recent testimony before the Committee on Tax Fairness and Family Prosperity chaired by Sen. Bob Jauch (D-Poplar).
 
Some Wisconsin legislators are now taking action to address the problem of corporate tax avoidance, which is costing the state millions of dollars during these extremely difficult fiscal times. Under Senate Bill 367, introduced on December 21 by Senator Dave Hansen (D-Green Bay), publicly traded corporations would have to file annual statements reporting income, state tax liability and other information.  The bill, called the Corporate Tax Accountability Act, would require the Department of Revenue to disclose the statements on the Internet two years after they are filed.

SB 367 reflects growing concern about the fairness of Wisconsin’s tax system, especially whether large, multistate companies are paying their fair share of taxes.  Under the bill, only large corporations would be required to file statements; small, privately-held corporations and non-corporate businesses would not be affected.

Hansen said the bill would provide the information needed to permit an informed discussion on this issue.  Republicans generally have been critical of the bill—Senate Republican Leader Scott Fitzgerald (R-Juneau) called it a first step toward raising taxes on business.

In recent years, there have been frequent reports of corporations avoiding Wisconsin taxes by shifting income to subsidiaries not taxable by Wisconsin.  Here are some of the strategies they have used, all of which have been challenged by auditors at the Wisconsin Department of Revenue and in other states:

  • Banks shifted stocks and bonds to subsidiaries in Nevada, which has no corporate income tax, and did not report the income from those investments on their Wisconsin returns.  The subsidiaries did not file Wisconsin tax returns because they had no physical presence in this state.  Essentially, banks sought to avoid paying state corporate income tax on their investment income.
  • Retailers transferred trademarks to subsidiaries in Delaware, which does not tax corporations when their only income is from intangible assets like trademarks.  The parent corporation lowered their Wisconsin taxable income, often to zero, by deducting royalties paid to the subsidiary for use of the trademarks.  Because it had no physical presence here, the subsidiary did not file a Wisconsin tax return. 
  • Retailers transferred ownership of their stores to real estate investment trusts (REITs) that they owned.  The parent lowered Wisconsin income by deducting rent payments to the REIT.  The REIT paid no state (or federal) tax on this rental income because it distributed it to shareholders as dividends.  The parent corporation did not pay Wisconsin tax on the dividends, since they are exempt when the recipient corporation owns at least 70% of the entity paying the dividends.

SB 367 would require corporations to identify other corporations that they own or that own them, and to report deductions for management service fees, rent, royalties, interest and other payments to affiliated corporations.  This and other information on the statement should help the Department of Revenue and state policy makers identify tax avoidance practices and determine how extensive they are.  Any finding that they are extensive is sure to generate legislative proposals to combat them.

Because legislation closing these loopholes would increase corporate tax revenues, the business lobby and its allies in the legislature consistently refer to such measures as tax increases.  However, these proposals would seek to close off strategies that taxing authorities in Wisconsin and other states have successfully challenged.  Though Nevada investment subsidiaries, Delaware holding companies and REITs are perfectly legal entities, state tax auditors and courts have disallowed their use when they lack economic substance.  If there are better ways to combat these kinds of tax avoidance practices than the remedies available under current law, it makes sense for the state to consider them.

One potential solution is legislation to require a corporation and its subsidiaries to file a combined report of all their income and expenses.  Currently, a parent and its subsidiaries each file separate returns, but only if they have physical presence in the state.  Combined reporting pulls these returns together so that, for example, a retailer’s deduction for royalty payments to a Delaware subsidiary is exactly offset by the subsidiary’s income from those payments. As a result, the deduction does not have the effect of lowering Wisconsin taxable income.

Senate Democrats added combined reporting in the 2007-2009 state budget, but the provisions were removed in the Conference Committee.  According to Legislative Fiscal Bureau estimates, combined reporting would increase state corporate income tax revenues by $90 million annually.  In the last few years, five states have adopted combined reporting for their corporate business taxes: Vermont, New York, Michigan, Texas and West Virginia.  That brings to 21 the number of states requiring combined reporting. Our neighbors Illinois and Minnesota are among them. We encourage policy makers here in Wisconsin to join those 21 states in closing this loophole, which deprives Wisconsin residents of badly needed resources.