March 7, 2012
Press conference on closing the Delaware Loophole
Good morning. I am state Representative Phyllis Mundy, Democratic chairman of the House Finance Committee. Joining me today are House Democratic leaders, the Pennsylvania Budget and Policy Center, and the Clear Coalition.
We’re here today to talk about creating tax fairness and leveling the playing field for Pennsylvania businesses.
State Representative Reed's House Bill 2150 claims to close the Delaware loophole, a well-known tax avoidance strategy many multistate corporations use to dodge Pennsylvania’s Corporate Net Income Tax.
But you should know that House Bill 2150 is simply smoke and mirrors with regard to the Delaware loophole. It is simply does not do what Rep. Reed claims.
The language is so broad and riddled with exceptions that it is ineffective and meaningless in terms of closing the Delaware loophole.
Before I explain why Delaware loophole provisions in HB 2150 are nothing more than window dressing, I'd like to remind you how the Delaware loophole works.
One of the best known examples is Geoffrey Giraffe from Toys “R” Us.
It works like this:
Toys “R” Us sets up a holding company or subsidiary in Delaware to control the Geoffrey Giraffe trademark. Delaware does not tax royalty income.
The Delaware-based Toys “R” Us holding company then charges the Toys “R” Us retail stores a royalty payment for using the Geoffrey trademark.
That allows the Toys “R” Us stores in Pennsylvania to treat the royalty payment as a business expense, which reduces the company’s income here and, in turn, its tax obligation to the commonwealth.
Tax avoidance schemes like the Delaware loophole are so effective at reducing the tax burden for big, multistate corporations that 85 percent of corporations in Pennsylvania now pay less income tax than a family earning around $36,000 a year.
This statistic is even more appalling when you consider that 70 percent of corporations pay no Corporate Net Income Tax at all in Pennsylvania.
That is just plain wrong.
It’s not fair to working Pennsylvanians who pay their income taxes. It’s not fair to middle class families, seniors and retirees who pay their property taxes. And it’s not fair to small businesses and good corporate citizens that pay their taxes.
This is a matter of basic tax fairness. The Delaware loophole is not fair, and it must be closed. But the Reed bill is the wrong approach.
The Reed bill, House Bill 2150, would still allow companies to deduct expenses for trademarks, copyrights and patents, merely by claiming they were for a legitimate business purpose.
This creates a loophole within a loophole as corporations would have little trouble finding a reason to claim a “legitimate business purpose” in order to avoid paying their fair share of taxes.
There are also problems with enforcement and who bears the burden of proof under the Reed bill.
Other states with similar legislation require companies to demonstrate why these deductions are legitimate. House Bill 2150 would place the burden of proof on the Pennsylvania Department of Revenue instead of the corporation itself.
That's a difficult and expensive hill for the Department of Revenue to climb, especially when the governor is calling for additional cuts to the agency’s general government operations.
To make matters worse, the Reed bill also presumes that any of these transactions conducted at fair market prices are legitimate.
This creates a blanket exemption, where a corporation could claim royalty payments and other expenses set at fair market value as tax exempt – thereby still avoiding paying its fair share of taxes.
As you can see, the Reed bill fails to close the Delaware loophole.
But there's more.
The Reed bill also allows multistate corporations to double dip by claiming a credit for taxes paid in other states and deducting that expense from their taxes here in Pennsylvania.
It also continues to allow companies to shift income out of state by deducting interest on loans from related companies – another strategy used by multistate corporations to reduce their tax obligation.
Last April, I introduced House Bill 1396 which would implement unitary combined reporting to close a wide array of corporate tax avoidance schemes, including the infamous Delaware loophole.
House Bill 1396 would require corporations and their subsidiaries to jointly file one tax report and pay taxes according to the amount of business activity conducted in Pennsylvania.
It shifts taxation from a structural to an economic basis, thus preventing multi-state corporations from using their corporate structures – often a complex web of dummy subsidiaries – to hide profits and avoid taxes.
Twenty-three other states have enacted combined reporting legislation.
My combined reporting bill would also lower the Corporate Net Income Tax to help make Pennsylvania competitive with other states.
I still believe House Bill 1396 is the best and most comprehensive approach to true tax fairness. But I also recognize the political reality that neither Governor Corbett nor the Republican leadership in the House and Senate will support such legislation.
That's why I'm introducing legislation that truly does close the Delaware loophole. It uses the add-back provision, as does House Bill 2150. Only my legislation does it right.
My new bill is modeled after the Multistate Tax Commission’s language which would require corporations to “add back” expenses from the use of patents, trademarks and copyrights and interest expenses to their taxable income.
It also would set a higher standard for allowing these types of tax deductions, and puts the burden of proof where it belongs – on the companies.
In the spirit of tax fairness, my bill would reduce the Corporate Net Income Tax from 9.99 percent to 6.99 percent over six years, beginning in 2014 as does the Reed bill.
Right now, small businesses in Pennsylvania are paying more because multistate corporations are manipulating the rules to avoid paying their fair share.
We can start to change that. But we have to do it the right way.
As Revenue Secretary Dan Meuser told the Associated Press in a recent news article about the Reed bill, we don’t want “a short-term answer that sounds good.”
He’s right. We want real tax fairness that gets the job done.
My bill will do just that.