It’s Time to Close the Delaware Loophole

Posted by By at 13 April, at 22 : 48 PM Print

by Eric Epstein

The term loophole is derived from loupe which refers to  a narrow   opening in a wall. These slit-like windows or  “loopholes” were located in medieval castles, and used to  defend royal courts from incoming projectiles.

Modern-day corporate castles exploit antiquated loopholes to deflect their tax burden to small businesses. The primary  tax avoidance vehicle for  corporate behemoths is the Passive  Investment Company (“PIC”) subsidiary. The most infamous  PIC is the Delaware tax loophole also referred to as “Geoffrey  the Giraffe.” (Geoffrey is the Toys R’ Us “intangible” holding  company.)

Here’s how the scheme works: Under the corporate fiction  of the Delaware tax loophole, local outlets of large national chain  stores pay royalties to sister companies in other states, claiming the payments as business expenses, and then deduct them from their Pennsylvania state income taxes.

In other words, “Geoffrey the Giraffe” allows large  corporations to pay little state income taxes in Pennsylvania.  Comcast, Crown Cork, Toys R’ Us and Wal-Mart are among  the corporations that minimize their Pennsylvania income tax  contributions through “intangible holding companies.”

However, many states have closed the Delaware loophole.  Back in 2004, the Governor’s Business Tax Reform Commission released a bipartisan report recommending changes to  Pennsylvania’s medieval tax structure. The 12 member  Commission endorsed numerous measures to level the  playing  field, including uniform reporting to eliminate  the Delaware loophole.

That same year, Maryland officials attempted to  collect approximately $80 million in back taxes, interest and penalties from 72 corporations who used the PIC tax  moat. When Maryland abolished the loophole,  Philadelphia-based Crown Cork & Seal’s Delaware holding  company appealed the legislation. Crown used the Delaware  holding company to shelter income earned in Maryland   from state taxes.

The Maryland Court of Appeals ruled that Crown could  be taxed because it “had no real economic substance” as a  separate business entity. Crown’s Appeal to the Supreme  Court was also rejected.

For small businesses without interstate operations, the  Delaware Loophole is not an option. This tax scam forces  small businesses to shoulder a bigger share of the state tax  burden. In fact, the Department of Revenue reported Pennsylvania taxpayers lost $493 million through this  loophole or approximately 35% of the sum paid in state  business taxes last year.

So, what do passive investment companies look like?  Just take a virtual field trip to the top tiers of the Rodney  Square in Wilmington, Delaware, and you’ll find a who’s who  of tax dodging. This building’s upper-floors serve as the   “brass plate” headquarters to hundreds of corporations, including British Airways, Colgate-Palmolive, Comcast,  GE, the Hard Rock Cafe, Ikea, Nabisco, Pepsico, Seagram  and Royal Dutch Shell.

How do 700 corporate headquarters squeeze into five  narrow floors? How do 500 fit on the 13th floor alone?  “Frankly, it’s none     of your business,” said Sonja Allen,  part of the staff that runs this corporate center for  Wilmington Trust Corp. . . Some of my clients are  saving  over $1 million a month, and all they’ve done is bought the Delaware address,” said Nancy Descano, holding  company chief     of CSC Networks outside Wilmington.   (Joseph N. DiStefano, “In the War Between the States,  Delaware is Stealing the Spoils,”Gannett News Service.)

It’s past time to close the loop, and fast-track Pennsylvania’s tax laws into modern times. Enacting uniform reporting and  eliminating the Delaware loophole is about tax fairness. Legislation  to nullify corporate tax-avoidance strategies allows the primary  engine of American capitalism – small business – to compete on a  level playing field.

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