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Posted January 24, 2008
Frequently Asked Questions
Understanding Business Income Tax Loopholes and the Food
& Business Tax Fairness Act
Quick Links to Common Questions
Q.
Why does Tennessee allow multi-state companies to take tax
breaks that are not available to in-state companies?
A. We can't answer
this question, but it seems to us that it's time for the
citizens and especially the business community of Tennessee
to come together to demand that the General Assembly put
an end to these tax breaks.
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Q.
Why do you say the food tax is unfair?
A. A Tennessee
family earning in the lowest 20% spends over 20% of its
income on food. A family in the top 20% spends only 4% of
its income on food (even though the dollar amount is greater).
Thus, the food tax hits the lower income family 5 times
as hard as the affluent family.
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Q.
Aren't Food Stamps and WIC vouchers exempt from sales tax?
A. Yes, but those
are only supplements that do not provide full nutrition
for a family. Also, many low and moderate-income families
do not qualify for those programs.
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Q.
Isn't the food tax the most stable part of TN's tax system?
A. Stability
is not the primary problem with Tennessee's tax system.
The lack of natural growth is. While the food tax is fairly
resistant to short-term economic fluctuations, it is an
extremely slow-growing revenue source over the long term.
Because of its heavy reliance on sales and other consumption
taxes that do not grow with the economy, Tennessee has a
persistent structural deficit in its tax system. As time
goes by and inflation increases the cost of government,
TN must pass new laws to raise the rate of its consumption
taxes; the current tax base does not grow with the economy.
Business taxes, by comparison, are fairly high-growth taxes
over the long term. Substituting a portion of the food tax
with revenue generated by closing corporate tax loopholes
would help make Tennessee's tax system more "elastic"
or responsive to economic growth.
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Q.
Isn't there a budget deficit this year that would make cutting
the food tax difficult?
A. In recent
reports, the administration has stated its intention to
meet the current budget shortfall by using savings that
occur naturally from unfilled positions, programs that start
later than expected or programs that run more efficiently.
While these are effective short-term solutions, the Food
and Business Tax Fairness Act would help address the long-term
budget challenges. It would replace a portion of the slow-growing
food tax with business taxes that are far more responsive
to economic growth. This approach would put our tax system
on more solid fiscal ground as we move forward.
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Q.
Would cutting the food tax make a TN personal income tax
necessary?
A. TFT believes
that the creation of a balanced, common sense tax system
will ultimately require a state income tax, as part of a
comprehensive tax-restructuring package. The issue of a
comprehensive tax package, however, is a much larger debate
than whether or not we should cut the state food tax.
In practice, there is little connection between states
that tax food and states that have an income tax. Of the
9 states without a broad-based income tax, only 2 tax food
(Tennessee and South Dakota). Of the 41 states with a broad-based
income tax, 12 tax food. The reason there is such little
correlation between the two is that the food tax represents
a very small, yet very unfair, portion of state revenue.
In Tennessee, it represents less than 2% of the overall
revenue, an amount that could easily be replaced, even without
a state income tax. corporations would be paying less tax.
Then why are they opposed to it?
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Q.
How would the Food & Business Tax Fairness Act benefit
Tennessee businesses?
A. Small
and medium-sized businesses that operate only in Tennessee
(and perhaps a few multi-state businesses that voluntarily
pay their full Tennessee taxes) are subsidizing those multi-state
businesses that avoid TN taxes. Such businesses minimize
their TN taxes through elaborate restructuring of their
subsidiary businesses to take advantage of loopholes in
Tennessee's tax code.
If all multi-state corporations paid their full tax obligations,
we could all pay less tax on our food, and future tax increases
could be delayed or avoided altogether. Also, businesses
that compete directly with large multi-state corporations
might be able to compete more effectively when their competitors
have the same tax obligations.
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Q.
How do you plan to close the loopholes?
A. There is a
mechanism called "combined reporting" that is
now the law in 21 of the 45 states that have a corporate
income tax. California was the first state to introduce
"combined reporting" in 1937. Sixteen states have
used this approach since 1983 or before. Since 2004, Vermont,
Texas, West Virginia, New York and Michigan have joined
the movement. The governors of Iowa, Massachusetts North
Carolina and Pennsylvania have recommended "combined
reporting" for their states. The Multistate Tax Commission,
a collaborative effort of state departments of revenue,
has advocated "combined reporting" and is distributing
a model law it approved in August 2006.
Michael Mazerov of the Center on Budget and Policy Priorities
(CBPP) and Dr. William F. Fox of the UT Center on Business
and Economic Research have advocated "combined reporting"
for years. Charles McLure, Senior Fellow at the Hoover Institution
and Deputy Assistant Secretary of the Treasury during the
Reagan Administration said, "Failure to require unitary
combination is an open invitation to tax avoidance.
(Or „ to the extent transfer prices are misstated
„ is it tax evasion?) The advent of electronic commerce
exacerbates the potential problems of economic interdependence
and manipulation of transfer prices." Charles E. McClure.
"The Nuttiness of State and Local Taxes and the Nuttiness
of Responses Thereto". State Tax Notes, September 11,
2002, p. 851.
The Supreme Court has twice upheld the fairness and constitutionality
of "combined reporting".
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Q.
What is "combined reporting"? What loopholes will
it close?
A. "Combined
reporting" is a comprehensive solution to plug most
of the largest loopholes in state corporate income tax systems.
It nullifies the benefit of "PICs", "nowhere
income", "transfer pricing", "captive
insurance companies" and "stashing" income-earning
assets in tax haven states.
See Michael Mazerov. State Corporate Tax Shelters and the
Need for Combined Reporting. Center on Budget and
Policy Priorities. October 26, 2007. For a detailed
discussion of some of the major corporate tax shelters and
tax-avoidance strategies to which states that have not adopted
"combined reporting" are vulnerable, consult:
http://www.cbpp.org/10-25-07sfp.pdf.
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Q.
Didn't Tennessee already close these loopholes a couple
of years ago?
A. Tennessee
has enacted a host of changes to corporate excise tax law
in recent years. However, few of these have any bearing
on combined reporting. The only one that does was a 2004
change that required companies to disclose transfer payments
made to Delaware holding companies or PICs on their tax
returns. While this may help the Department of Revenue gather
good data, it does not actually "close" the loophole.
Instead of taking a piecemeal approach, "combined
reporting" goes to the core of the problem with a simple,
common sense solution. By requiring corporations to report
all their related subsidiaries as one business for tax purposes,
"combined reporting" nullifies all the loopholes
that hinge on the ability to shift profits back and forth
among subsidiaries.
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Q.
How does "combined reporting" work?
A. "Combined
reporting" is the alternative to the current system,
"separate entity reporting" for corporate income
tax calculation in TN. Most multi-state businesses are organized
as a "parent company" and multiple subsidiaries
with defined functions. "Separate entity reporting"
states require each separate entity (parent or subsidiary)
that conducts business in the state to file its own income
tax return. This type of reporting leaves the door open
for businesses to transfer their income from one subsidiary
in a state that would tax it to another subsidiary in a
state that would not tax it.
"Combined reporting" states require businesses
that operate in their state to file one tax return combining
the income and expenses of the parent company and all its
subsidiaries that operate in the same "unitary"
business. The income is then apportioned among the states
according to a formula that includes factors for payroll,
real estate and sales.
Q.
What is a "unitary business"?
A. A unitary
business is an integrated economic enterprise. One example
is a retail business with transportation, storage, real
estate management and marketing subsidiaries. If that company
also owns a subsidiary cattle ranch, with independent management
and sales to outside buyers, the subsidiary would not be
part of the unitary business. If the subsidiary sold its
beef in the retail stores, however, it would be part of
the unitary business.
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Q.
Won't clever lawyers and accountants just devise new schemes
to avoid state taxes?
A. They may,
but "combined reporting" leaves less "wiggle
room" and smaller amounts of income available for tax
sheltering. Other loophole-closing approaches focus on one
scheme at a time, and are subject to more court challenges.
Since "combined reporting" has been around so
long, has been upheld by the Supreme Court and is now supported
by a model statute and model regulations promulgated by
the Multistate Tax Commission, the lawyers and accountants
will have to earn their fees.
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Q.
What companies are most aggressive about sheltering their
income from state taxes?
A. Corporations
consider their tax returns confidential, proprietary information.
Thus, it is very difficult to get solid information about
their tax reduction strategies. The information that is
available comes from court cases between corporations and
state departments of revenue trying to enforce their laws
and collect taxes they believe were due. State Corporate
Tax Shelters and the Need for Combined Reporting article
cited above lists 49 companies known to have used "PICs".
Another study reviewed 252 corporations and compared the
total state and local income taxes corporations reported
in their federal income tax filings. The study listed state
income tax rates for the years 2001 to 2003. It found that
71 companies paid no state income taxes in at least one
of those years. The aggregate effective tax rate paid over
those three years was 2.6%. while the average rate, according
to state laws, was 6.8%.
Five of those 252 companies were headquartered in Tennessee.
The companies and their respective aggregate state taxes
paid were: Dollar General, 2.4%; Autozone, 2.8%; FedEx,
3.2%; Caremark, 3.5% and HCA, 3.6%. Tennessee's statutory
corporate income tax rate is 6.5%.
See Robert S. McIntyre and T.D. Coo Nguyen, State Corporate
Income Taxes 2001-2003, Citizens for Tax Justice. February
2005. A detailed study of the low aggregate state
corporate tax payments made by many of the largest corporations
in the U.S. can be found at: http://www.ctj.org/pdf/corp0205an.pdf.
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Q.
Is it legal for these companies to dodge so much of their
tax liability?
A. Yes. Tennessee's
tax law is so lax that multi-state companies routinely exploit
the 18-wheeler sized gaps in the tax code.
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Q.
How much revenue would full "combined reporting"
generate in Tennessee?
A. Because corporations'
tax returns are treated as confidential, proprietary information,
it is difficult to know with certainty how much revenue
would be generated by "combined reporting" in
Tennessee.
The most detailed study on revenue generated through "combined
reporting", prepared by the Pennsylvania Department
of Revenue, received an award for best research by a state
revenue department from the Federation of Tax Administrators.
That study found that "combined reporting" would
increase business income tax revenue by 24%. Based on the
following table, TFT estimates additional business income
tax revenue in the range of 12-25%. Tennessee's projected
business income tax revenue for 2007 is around $1 Billion.
This figure suggests that "combined reporting"
could result in additional revenue between $120 and $250
Million.
Earlier studies produced the following results for other
states:
|
Projected Increase in Corporate
Income Tax Revenue Due to Combined Reporting |
Dollar
increase (millions) |
Percent
Increase |
|
Wisconsin |
70 |
13.0 |
|
Iowa |
25 |
13.5 |
|
Vermont |
5 |
14.2 |
|
Maryland |
85 |
19.6 |
|
Florida |
238 |
24.8 |
Source: Massachusetts Budget and Policy
Center, Setting the record Straight on Combined Reporting,
March 30, 2004, http://www.massbudget.org/recordoncr.pdf
(data from respective state governments)
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Q.
Are there other measures Tennessee should take to tighten
up its tax laws?
A. Yes. Tennessee
needs to add a "throwback rule" section that states:
"Sales of tangible personal property are in Tennessee
if the property is shipped from an office, store, warehouse,
factory, or other place in this State and the taxpayer is
not taxable in the State of the purchaser". Tennessee
should also define business income as "all income which
is apportionable under the Constitution of the United States."
Michael Mazerov, Center on Budget and Policy Priorities,
"Closing Three Common Corporate Income Tax Loopholes
Could Raise Additional Revenue for Many States," May
23, 2003.
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Q.
How do you respond to multi-state corporations' assertions
that "combined reporting" would hinder economic
development?
A. "Combined
reporting" states are disproportionately among the
most economically successful. From 1979 to 2000, when manufacturing
employment peaked in the U.S., "combined reporting"
states constituted: 4 of the top 5 states in manufacturing
job growth, 7 of the top 10 states in manufacturing job
growth, 10 of the 17 states with positive manufacturing
job growth, and only 6 of the 33 states with zero or negative
manufacturing job growth.
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Q.
How do you respond to multi-state corporations' assertions
that "combined reporting" is unworkable and has
caused lots of litigation over definition of "unitary
business"?
A. There has
been considerable litigation over what constitutes a "unitary"
business because such litigation is about the only course
available to businesses to protect their tax avoidance schemes.
Now that the Multistate Tax Commission has prepared a model
statute and clear, enforceable definitions and regulations,
such litigation should become less common. In any case,
there has been no more litigation about unitary businesses
than about laws specifically targeting only "PICs"
or other "tax planning strategies".
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Q:
Which states are the common tax haven states?
A: Nevada and Delaware.
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Q:
How would the new revenue be used?
A: To fund further
reductions in Tennessee's regressive food tax. However,
we understand that whenever a new source of revenue is introduced,
everyone wants a piece of it.
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Q.
Doesn't the Commissioner of Revenue have the authority to
require "combined reporting"?
A. Yes, but only
on a case-by-case basis and when he has reason to believe
the taxpayer has underreported income. Exercising that authority
would almost surely lead to litigation and the cost-benefit
ratio would be too high to make it worthwhile. Mandatory
"combined reporting" would be much more efficient
and place the responsibility for the law where it belongs,
on the citizens of Tennessee.
In an article in the prestigious National Tax Journal,
Economists William F. Fox, Matthew N. Murray, and LeAnn
Luna wrote: "[W]e argue for "combined reporting"
in all states. This conclusion is based in part on
economic considerations that are independent of any tax
planning opportunities, such as the practical problems associated
with measuring economies of scope across related firms.
But "combined reporting" can also lessen tax planning
distortions based only on corporate form that waste resources
through avoidance and government oversight activities. William
F. Fox, Matthew N. Murray, and LeAnn Luna. "How Should
a Subnational Corporate Income Tax on Multistate Businesses
Be Structured?" National Tax Journal. March 2005.
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