Columns » Ernest Dumas

Arkansas: tax haven

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This is about certain passive subsidiaries, but don't leave just yet. The subject is not as boring or as irrelevant as you imagine. You're paying handsomely for them.

The New York Times reported last week that a growing number of states are trying to shut down corporate tax dodges as a way of closing their yawning budget gaps as state revenues from taxes on depressed workers and consumers shrink. They are developing ways of taxing the huge profits that multistate corporations hide by tucking them away in paper subsidiaries in states like Delaware and Nevada that have become tax havens. The states are driven not only by the quest for revenues to support state services but, we'd like to think, by a recognition that they ought to be fair to small businesses that pay their taxes but have to compete with giants that rake in their profits virtually tax free.

President Obama raised hackles with the chamber of commerce by promising to crack down on companies that evade federal income taxes by planting their profits in offshore tax havens. The offshore havens, like Switzerland and the Cayman Islands, are retaliating by calling the United States a tax haven because it permits some of its states to do the same thing.

But state governments and their taxpayers have a bigger problem with tax havens than Uncle Sam does. Their tax losses run into the tens of billions.

Twenty of the 45 states with corporate income taxes have adopted a strategy known as combined reporting, which aggregates the profits from a company's subsidiaries for state tax purposes.

No, you didn't have to ask. Arkansas is not among them, although the legislature toyed with the idea for several years. An old-time Republican lawmaker, who thought the government ought to provide a level playing field between small businesses and the multistate behemoths, introduced bills to stop the corporations from laundering their profits through passive subsidiaries incorporated in Delaware, Nevada, Wyoming and South Dakota and in a few other states with favorable corporate tax codes. Rep. Phil Jackson of Berryville, a small businessman himself, was squashed every time he filed the bill. Chamber lobbyists said Arkansas would become known as a business-hostile state. The Arkansas Democrat Gazette editorialized that the old Republican had filed the “worst bill” in the legislature.

So, instead, the legislature raised sales taxes and cigarette taxes and plugged a few tax loopholes for workers and consumers to raise the necessary cash for schools, colleges, a trauma network and other health services.

The state Finance and Administration Department can't hazard even a rough guess about how much money the treasury is missing each year by not making the big corporations pay the same share of taxes on their profits in Arkansas that home-grown small business competitors do.

Here is a clue about how much money the state is losing. Do you think Exxon, Mobil, Chevron and the other petroleum giants made any money in Arkansas from soaring gasoline prices the past couple of years? Corporate tax records at the Capitol are confidential, but unless they have changed since court filings a couple of years back the oil companies aren't paying much in the way of Arkansas income taxes.

It works this way: A company's business in Arkansas is retail sales. Subsidiaries in other states, perhaps the exploration company, charge the retail outlets high prices for gasoline and petroleum products, which are carried as an expense against taxes for the retail division in Arkansas. The profits are reported in a state with no income tax or a tax code that is favorable for the industry.

Arkansas loses by a couple of other tax dodges created the past 20 years by the big accounting firms. Ernst & Young LLP came up with a plan to help Wal-Mart escape much of its state and local tax burdens. It created investment holding companies called real estate investment trusts (REITs). Other companies have followed suit. A multistate company will create a subsidiary that will hold title to the buildings and land on which Wal-Mart and Sam's stores sit. Incorporated in a tax-free state, the subsidiary collects a high rent from the stores, which then report the rent as an expense on the company's state returns. Often the subsidiary lends the money it collected back to the parent company, which carries the loan obligation as an expense, so the company is borrowing from itself and taking a tax break on it.

Filings in a North Carolina court case showed that Wal-Mart and Sam's paid captive subsidiaries $7.27 billion in rent between 1998 and 2001. Citizens for Tax Justice estimates that Wal-Mart cut its state income taxes in half.

Another gimmick is to create a subsidiary in Delaware with nothing more than a piece of paper. The subsidiary will own the company's trademark. The subsidiary will charge a high fee for all the company's stores to use the trademark or logo, which will virtually eliminate profits and taxes at the state level. The money is paid back to the company as tax-free dividends.

One small street in Wilmington, Del., is home to 6,500 such subsidiaries. One file clerk may service hundreds of them.

So which seems fairest to you: a little higher tax on your kid's shoes, a steeper tax on tobacco, or making Home Depot pay the same taxes on its profits that little struggling Hocott Nursery on Kavanaugh Boulevard pays? For Arkansas lawmakers, the answer is always the same.

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