Big Firms Get Big Breaks

Time to Reform the Reforms
By Mary E. Forsberg

Gaming The System

News reports about companies like Enron breaking the law and suffering the consequences attract considerable attention. The public hears much less often about efforts undertaken daily by businesses trying to reduce or eliminate their tax liability. These activities are quiet, for the most part, because they are legal. Arguably, though, they often stretch the bounds of what was intended when tax laws and regulations were enacted-and they cost taxpayers a lot of money because someone has to make up the difference between what a state needs and what it is able to collect from business taxes.

A lot of what companies do to avoid taxes involves their ability to game a system under which one state’s tax laws might differ considerably from another’s. One example is the case of multi-state corporations artificially shifting income to corporations they own in low-tax or no-tax states. The “Geoffrey” case was one of the best known of these strategies. Geoffrey the Giraffe is the trademark of Toys R Us. The toy company created a company in Delaware that owned that trademark, and Toys R Us stores in many states paid this Delaware company a fee for using the trademark. This effectively shifted profits out of higher tax states and into Delaware. This was an advantage for Toys R Us because Delaware does not levy corporate income taxes on earnings from such intangible assets as trademarks. So, profits transferred in this manner are free of state corporate income taxes.

This practice originated in the mid 1980s and grew rapidly over the next decade. A number of large accounting firms actively market their expertise in helping clients figure out such loopholes. Because companies are not required to publicly disclose these transfers, it is not possible to know how much profits are being sheltered or taxes avoided through these schemes. When court cases have been brought against some of the retailers involved in such ploys, the findings have revealed millions and sometimes billions of dollars in transactions-with substantial state corporate tax losses.

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