[Corp. Watch] Ciao, Taxes: Corporations 'hide out' overseas to dodge state revenue laws

Corporation Watch corporation-watch at countercorp.org
Tue Apr 22 03:29:38 EDT 2008

Why Wal-Mart Set Up Shop in Italy

By Jesse Drucker

(Wall Street Journal, Nov. 14, 2007) -- More than 4,500 miles
separate a small Wal-Mart office in Florence, Italy, from the
company's dozens of Illinois retail outlets. But thanks to a
convoluted tax arrangement, Wal-Mart's Italian operation has helped
the giant retailer cut its state tax bill in Illinois by millions of
dollars a year.

Wal-Mart's Italian outpost is the only operating unit of a real-
estate subsidiary that controls billions of dollars of the retailer's
property in Illinois and other states. Because technically its only
employees are based in Italy, the real-estate unit claims its
operations are foreign, and thus exempt from Illinois corporate
income taxes.

Earlier this year, the Illinois Department of Revenue objected to
the Italian tax maneuver, demanding $26.4 million in back taxes,
interest, and penalties. Wal-Mart paid the amount in dispute and then
sued the state for a refund, according to a complaint filed in May in
Illinois Circuit Court in Springfield, Ill.

A Wal-Mart spokesman declined to comment beyond a prepared
statement: "We have a disagreement with the state of Illinois over
our tax liability last year, and we've asked a judge to resolve that
for us."

He declined to explain why Italy was chosen as the home of this
particular foreign operation, or whether Wal-Mart has other such

The dispute with Wal-Mart is part of a wider effort by some states
to crack down on what they believe is abusive use of so-called
"80/20" companies. These companies are domestic subsidiaries of
domestic corporations that conduct at least 80% of their business

States typically don't tax income from outside the U.S., and many
companies have used 80/20 subsidiaries to legitimately shield foreign
operations from state taxation.

But authorities in several states have challenged a number of
companies over the 80/20 units, claiming the structure was used to
improperly shift income away from the purview of state taxing

The misuse of 80/20 companies is "shocking to the conscience," said
Brian Hamer, director of the Illinois Department of Revenue. "These
kinds of manipulations clearly were never contemplated by the state

"It ought to have been clear to businesses that this was highly
questionable conduct," added Hamer, who wouldn't comment on any
single company or legal case.

Illinois tax authorities are also in a dispute with McDonald's over
nearly $11 million stemming from its use of an 80/20 subsidiary.
Details are sketchy, but McDonald's, based in Oak Brook, Ill., says
in court papers that a Delaware financing unit that owns restaurants
in St. Thomas, Virgin Islands, conducts 80% or more of its business
activity outside the U.S., exempting its operations from being
included in Illinois tax calculations.

"We believe the results of our business have been properly reported
to the state of Illinois," said a McDonald's spokeswoman.

Minnesota, BNSF Wrangle

Meanwhile, Minnesota tax authorities are taking issue with interest
payments made by the Burlington Northern Santa Fe railroad to a pair
of its Delaware subsidiaries doing business in Canada.

The railway company deducted the interest associated with the
payments, but didn't pay taxes on most of the income received by the
subsidiaries. The state's revenue department says in an audit report
that this was "done purely for tax avoidance purposes."

The Fort Worth, Texas, company paid a disputed $4 million in back
taxes and interest in the case, and then sued the state in May for a
refund. A Burlington Northern spokesman declined to comment.

States Crack Down

At the prodding of the Illinois revenue department, that state's
legislature in 2004 passed a law essentially shutting down the
abusive use of 80/20 units. The Minnesota state legislature enacted
one change in 2005, and has considered several other bills since then
to shut down alleged abuse of the structure.

Wal-Mart's Italian tax-planning maneuver is the latest disclosure of
a strategy by the firm to cut state taxes.

A page-one article in the Wall Street Journal in February focused on
how the Bentonville, Ark., retailer cut taxes in some states by
paying rent to a real-estate investment trust (REIT) it owned, even
though the money never left the firm.

That REIT strategy has been challenged by tax authorities in several
sates; some have enacted laws to close the REIT structure since the
Journal article.

However, the REIT tax structure saves corporations money only in
states that tax income solely from operations within their borders.
This taxation system, known as "separate reporting," can make it
simpler for companies to shift income out of state to tax-friendly
jurisdictions such as Delaware or Nevada.

But "combined reporting" states such as Illinois are much tougher.
They add together all profits of a company's domestic operations,
regardless of what state they are in, and then allocate a portion of
those profits to their state.

Theoretically, combined reporting makes it harder for companies to
shift income to more advantageous locales. Because Illinois rules
apply only to domestic profits --- not world-wide income -- companies
can get around the rules by figuring out ways to effectively shift
income overseas.

Wal-Mart's 80/20 structure worked like this: The company first
transferred its Illinois stores to its in-house REITs, paid rent to
the REITs, and then deducted those payments from its taxes as
business expenses. The REITs, in turn, paid that money to their 99%
owner, a Wal-Mart unit based in Delaware.

Ordinarily, Illinois's combined-reporting rules wouldn't permit a
company to cut its taxes by shifting income to a Delaware unit. But
in late 2001, Wal-Mart formed a Delaware subsidiary called WMGS
Services LLC, court records show.

WMGS, with offices in Florence, Italy, was a wholly owned subsidiary
of Wal-Mart Property Co., which also was 99% owner of Wal-Mart's main

In its court filing, Wal-Mart contends that Property Co.'s ownership
of the Italian unit converted Property Co. into an 80/20 company --
in other words, at least 80% of its employees and its property were
overseas, exempting its income from taxes.

Though Property Co. is the 99% owner of the REIT -- which owns
dozens of Wal-Mart stores in Illinois -- Wal-Mart says Property Co.
owns no real estate itself. And although Wal-Mart has more than
48,000 employees in Illinois, the firm contends Property Co. has no
employees in the state, either.

The only employees of Property Co. were in Italy, the company says.
Property Co. was set up to own the majority of the shares of Wal-
Mart's main REIT and has no employees anywhere, Wal-Mart has said in
court records elsewhere.

(In its court filing in Illinois, Wal-Mart says that WMGS's
employees and property were in Turin, not Florence, Italy; but an
official with the company in Florence and a Wal-Mart spokesman in the
U.S. say the company doesn't have an office in Turin.)

WMGS employs 22 people at its office in central Florence, according
to a company official who answered the door there on a recent weekday
morning. The office is responsible for procuring merchandise from
around Europe, he said. Wal-Mart has no retail stores in Italy.

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