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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