by Beth McConnell
May 24, 2003
Not too long ago, corporate tax cheats thought they had to go all the way to Bermuda to avoid paying their fair share of taxes. But thanks to sophisticated tax attorneys and state tax laws that just haven't kept up with the times, today's corporations are getting a pretty good deal much closer to home.
Through one loophole popularized by Toys "Я" Us, known as the Geoffrey Loophole, major corporations are setting up Passive Investment Holding Companies (PICs) in tax-haven states such as Delaware, Nevada and Michigan. The existence of these PICs allows a company to use creative accounting to shift a significant amount of its end-of-year profit to a subsidiary in another state.
In the case of Toys "Я" Us, the mega toy-retailer created a subsidiary called "Geoffrey, Inc." in Delaware. This subsidiary legally holds the patents, trademarks and other intellectual property Toys "Я" Us needs to do business. Geoffrey kindly agreed to lease back the right to use those patents and trademarks in exchange for royalties. Once paid, Toys "Я" Us stores across the nation have reduced their in-state taxable profit by a sizeable amount. In 1990 alone, Geoffrey, Inc. received more than $55 million in such royalties from Toys "Я" Us stores across the nation, as revealed in a South Carolina State Supreme Court brief. Since Delaware does not assess corporate taxes earned from royalties, shareholders of the toy giant are $55 million wealthier, while the states that relied upon taxes collected from that profit got the short end of the stick.
If that sounds outrageous in principle, think about what it means as states like Pennsylvania struggle with budget deficits in the billions. The Pennsylvania legislature passed the first part of a budget bill earlier this year that was devastating to drug and alcohol treatment programs, health assistance for the disabled, public-transit funding and other social assistance programs. And there's no relief in sight, as the newest budget shortfall projections have yet to offer good news.
It's impossible to know which or how many businesses are engaging in this sort of a shell game. Unlike federal tax filings, corporations' state tax filings are not open for public review. However, a recent investigation by The Wall Street Journal showed the existence of 33 such companies engaging in similar arrangements, including Home Depot, Staples, Burger King, Gap and many other big names around the country. In some cases, these parent companies are little more than brass plates and mailboxes. In fact, one Delaware office building is home to more than 700 corporate headquarters; over 132,000 Nevada-based corporations have no employees in the state.
Given that loophole, it's no surprise that corporate taxes are decreasing significantly as a share of Pennsylvania's General Fund, dropping from 26 percent in 1992 to 18 percent in 2003, according to the Keystone Research Center (KRC). KRC also found that an estimated 80 percent of corporations registered in Pennsylvania pay no Corporate Net Income (CNI) taxes, the principle state tax to which businesses are subject. But while many corporations avoid state taxes, their products are still shipped on the roads and bridges taxpayers pay to repair, and our publicly-funded court system handles their legal disputes. These businesses should be required to pay their fair share to fund those and other public services from which they benefit.
Pennsylvania taxpayers aren't the only ones getting the shaft. Only 23 states have closed this loophole, most of which did so through the adoption of a measure known as "combined reporting." Simply put, combined reporting allows the state to treat all related corporations as a single business for taxation purposes, regardless of where they incorporate. This removes any incentive corporations have to implement revenue-shifting measures, only one of which is the creation of PICs -- numerous other loopholes exist that drain millions from states each year.
Without leveling the playing field this way, states have given major corporations an unfair competitive advantage over small, home-grown businesses. During debates over closing the PIC loophole in New Jersey, it was revealed that a small, single supermarket in Bayonne paid $3,000 in corporate taxes while A&P -- with $1.5 billion in sales and close to 12,000 employees in the state -- paid as little as $200 that same year.
Closing these loopholes now will level the playing field, as well as allow states to earn back the revenue needed to operate this year and beyond. But equally important is giving the public the right to review corporate state tax filings. For as long as taxes exist -- and filings remain private -- creative accountants will be steps ahead of the public in identifying and exploiting loopholes to avoid paying their fair share.
Beth McConnell is the Director of the Pennsylvania Public Interest Research Group (PennPIRG). This article first appeared in TomPaine.com (www.tompaine.com)