As many US states face budget crunches, they are increasingly turning to the
courts to try to rein in corporations which minimise their state income tax
and sales tax costs with complex tax avoidance structures. While Congress has
been focusing on punishing companies that 'expatriate' to Bermuda or Barbados
for tax reasons by denying them access to government contracts, almost all large
US multi-state retailers use domestic low-tax districts such as Delaware or
Nevada to shelter large tranches of their income.
The strategies they use are legal, as long as they are properly executed, and
most times court action by a state is unsuccessful. Typically, corporations
locate intellectual property assets, real estate, and financing subsidiaries
in the low-tax area, allowing them to charge trading subsidiaries license fees,
rent and interest all of which are deductible for state income tax purposes.
The weak point for some companies may be that if they transferred an existing
asset into a new low-tax subsidiary simply for tax-minimising purposes then
the Court may unstitch that transaction. But if the transfer took place as part
of an acquisition, say, or if the low-tax holding company has specialist expertise
not available to the trading subsidiary, then the structure is probably quite
robust.
The Wall Street Journal reports however that the states are now launching a
major compaign to try to clamp down on tax avoidance, which has seen the average
effective state tax rate for corporations decline from 9.6% in 1980 to about
5.2% today. The list of corporations being targeted reads like a roll-call of
America's top retailers.
"It's a matter of fairness," says Norris Tolson, North Carolina's
Secretary of Revenue. "It's not fair to the corporations that do properly
report their income or to the millions of working people who pay their taxes
without trying to avoid them."
Corporations say in reply that their duty is to their stockholders, and they
are both entitled and obliged to set up a structure that is as tax-effective
as the law permits - and Courts have consistently backed this view, up to and
including the Supreme Court.
So far the jury is out on whether the states' initiative will be fruitful.
Some state-level courts have gone with the states, some with the corporations.
But in all cases judgements are being appealed, and it will be years before
the outcome is clear.
That is, unless Congress intervenes. But any attempt to constrain the tax policy
of a state would surely be unconstitutional? It's ironic, to put it mildly,
that some US states can get away with strategies denied to offshore tax havens.
