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

[Corporation Watch]

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  
arrangements.

	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  
overseas.

	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  
authorities.

	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  
legislatures."

	"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  
REIT.

	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.