Tennessee tax shelters

By Chas Sisk, The Tennessean

Tennessee is one of several states that allows companies to shift their profits into tax havens like Delaware and Nevada, resulting in potentially millions of dollars of lost revenue.

According to a new report released this week by researchers at the University of Tennessee, the state could close what critics describe as a major tax loophole without damaging the economy.

But analysts stopped short of calling for the General Assembly to enact a tougher reporting law to combat corporate tax dodges, which some believe could scare off companies wanting to invest in a state known for its friendly business climate.

Seven states have enacted such laws in the past five years, but the long-term impact is still unknown, they said.

"The bottom line is we think it makes sense," said Bill Fox, the report's lead author. "But we think the jury is still out on economic development and the impact on revenue."

At issue are corporate tax shelters that protect profits from state business taxes.

Tax authorities across the country have tried to stop multi-state corporations from shifting profits to lower-tax states through complicated leasing and licensing arrangements. In one high-profile case, the state of North Carolina ordered Wal-Mart Stores Inc. to pay $33 million in back taxes, penalties and interest.

The practices are legal, their defenders say. But critics say the methods shield the companies that take advantage of them from paying their share of the cost for state and local services, shifting the burden onto individuals and local businesses that are too small to take advantage of the same techniques.

State officials, however, are divided on whether lawmakers should crack down on the tax shelters. Legislation has been filed in Tennessee to do so, but Reagan Farr, the state's revenue commissioner, said attacking the problem through new laws could scare off potential investment in the state.

"Companies expect to pay tax when they go into a state, but they like stability and predictability," he said this week. "I believe this is abusive and needs to be addressed but that it can be addressed in a more targeted way."

States crack down

State tax shelters have come under heavy attack as states deal with crippling budget gaps and a deep recession.

The shelters vary in their particulars, but generally they work by transferring assets into a new subsidiary owned entirely by the corporation itself. Companies pay themselves fees to use those assets, then deduct those fees from their state income tax returns as a cost of doing business - even though no money ever leaves the corporations.

Bentonville, Ark.-based Wal-Mart got the attention of North Carolina tax authorities by transferring ownership of its stores in several states to a subsidiary incorporated in Delaware, where there are few corporate taxes. The company then paid that subsidiary rent for the use of those stores and deducted the rent as an expense, according to a front-page account published two years ago in The Wall Street Journal.

Authorities in North Carolina fined the company for the practice in 2005, but the company filed suit the next year seeking a refund. That suit is pending in North Carolina courts.

Wal-Mart has not been alone in the practice. Memphis-based AutoZone Inc. and Birmingham, Ala.-based Regions Financial Corp.'s AmSouth unit, among many others, have also bee n challenged by state tax commissioners outside Tennessee for practices that the states said improperly shifted profits over state lines to avoid paying business taxes.

AutoZone and Wal-Mart officials did not return calls seeking comment Wednesday. A spokesman for Regions said the practices were legal and similar to those in place at other companies.

The popularity of these techniques has prompted seven states - including Vermont and Texas - to try to stop the practice with "combined reporting" laws.

These laws require companies that do business within their jurisdiction to report all of their income, even that collected over state lines. The states then levy taxes based on the share of the companies' business that is actually done within their borders.

Many other states are believed to have attacked tax shelters during closed-door corporate audits. But without a combined reporting law, they have little power to stop the practice, said Michael Mazerov, a senior fellow with the http://www.cbpp.org/cms/index.cfm?fa=view&id=246">Center on Budget and Policy Priorities.

"If states don't have combined reporting, their corporate tax base is vulnerable," he said. "States have really awakened to how much of this activity has been going on."

Sixteen other states had combined reporting laws on the books before this more recent wave.

Use in Tenn. uncertain

It isn't clear the extent to which such tax-haven strategies have been used by companies operating in Tennessee.

The University of Tennessee report that came out this week, which was commissioned by the legislature and released by the state comptroller, said that because companies are not reporting their activities outside Tennessee to the Department of Revenue, they have no way of knowing how much profit is being shifted out of state.

Researchers were able to review states that have enacted combined reporting laws recently. They found that those states experienced a short-term jump in revenues.

They also concluded that combined reporting was unlikely to dissuade companies from opening stores or relocating to a state, since state taxes are generally far less costly than transportation, labor and other expenses.

But researchers also said combined reporting is not certain to increase tax receipts over the long haul. There is not enough data to judge the impact over the long term, and it is possible that Tennessee's particular tax laws might make its experience different.

"As a general practice, we would agree that it makes sense to combine companies' earnings," Fox said. "The devil is in the details."

State Sen. Tim Burchett, R-Knoxville, has introduced legislation that would require combined reporting and lower the sales tax on food. Tennesseans for Fair Taxation, a Knoxville advocacy group, also favors combined reporting.

Burchett and the TFT officials could not be reached for comment.

But Farr said he would continue to oppose combined reporting. Such a law would represent a major shift in tax policy for the state, he said.

Instead, he would prefer for the state to tackle the issue during audits.

"Every tax system is going to have to contend with opportunities for large, multistate corporations to structure themselves to pay less tax," Farr said. "If (a transfer) is done for pure tax avoidance, we can make adjustments (during an audit). It's more equitable."

Additional Facts
HOW IT WORKS
A company that does business over state lines can reduce or avoid state taxes:

1. The company sets up a subsidiary in a tax haven state that is entirely owned by the corporate parent.
2. Assets, like trademarks or real estate, are transferred to the subsidiary.
3. Other subsidiaries pay royalties or rent to the subsidiary.
4. Those payments are deducted on corporate tax returns as an expense, even though no money has left the corporation.