Alabama is far from high profile on the issue but has its moments. As the Legislature began considering tough budget measures in April, early proposals included plans to plug corporate tax loopholes, with some of those proposals backed by the governor’s office.
State Finance Director David Perry said he will implement a rules change at the Department of Revenue, where current policy for S-corporations and partnerships allows filers to deduct from their state taxes the total federal income tax they pay rather than just the percentage that applies to Alabama business. Perry estimates the change will bring in $30 million a year.
But Perry told Business Alabama the administration is not willing to pursue more comprehensive loophole-plugging policies known as combined reporting. Combined reporting, which has been adopted by 22 states, is used to prevent national retail chains like Walmart and McDonald’s from using accounting schemes to evade paying their full share of state corporate income taxes.
House Minority Leader Craig Ford told the Birmingham News he planned to introduce legislation aimed at capturing revenue from big tax avoiders, though the specifics were not clear. He said 16 companies operating in Alabama each reported more than $1 billion in federal income, but paid no state income tax.
Perry said the legislative track record is that combined reporting statutes will fail in Alabama: “It’s too controversial in the business community and too big a fight in the Legislature.” However, he said he hopes to attack “one of the most egregious aspects of non-reporting” of corporate income—transfer pricing.
Transfer pricing is the tax avoidance scheme whereby a company “inflates its business expenses at its Alabama operations and there is a corresponding inflation of income from operations in states that do not have any corporate income tax, ” Perry said.
“Yes, there will opposition to that as well, ” he added. Like combined reporting measures that have failed in the past and unlike the S-corporation rule change, transfer pricing measures will require an act of the Legislature.
Income tax returns are protected as confidential, so the Alabama Department of Revenue won’t tell you which companies are not paying taxes, but they will tell you how many. Here is the department’s summary of the non-payment of corporate income tax, expressed in a variety of ways, for the most recent year for which data is available, 2008:
• Of the 24, 673 corporations doing business in Alabama, 67.23 percent paid no state income tax.
• Of the 9, 993 corporations doing business in Alabama that paid federal income taxes, 26.75 percent paid no state income taxes.
• Of the corporations doing business in Alabama that reported over $5 million in total income, 30.84 percent paid no state income tax.
• Of the corporations doing business in Alabama that reported over $10 million in total income, 30.18 percent paid no state income tax.
• Of the corporations doing business in Alabama that reported over $25 million in total income, 29.28 percent paid no state income tax.
• Of the 150 largest for-profit employers in Alabama who are subject to the corporate income tax, 38.67 percent paid no state income tax.
• Of the 150 largest for-profit employers in Alabama who are subject to the corporate income tax and reported income, 38.98 percent paid no state income tax.
• Of the 150 largest for-profit employers in Alabama who are subject to the corporate income tax and paid federal corporate income taxes, 29.28 percent paid no state income tax.
Occasionally the names of the tax avoiders do come out, when they fight the state revenue department in court and the information becomes part of the court record. In 2003, Exxon made $89 million in Alabama and paid no state income tax, one case reveals.
How do they do it? For the most part it’s a simple accounting shuffle for companies big enough to have widespread operations. The Alabama operations make payments to the parent company that are deducted from the Alabama income tax return, then the revenue is added back to the balance sheets of the Alabama operations as a non-taxable dividend from the parent company. Exxon deducted $418 million from Alabama income taxes in this way, which the revenuers call the add-back tactic.
The Administrative Law Division of the Alabama Department of Revenue has a collection of such cases that have been through the courts, including: $833 million in payments Lowe’s Inc. deducted to itself, reducing its Alabama income by $25 million; $500 million McDonald’s Corp. deducted in payments to itself, reducing its Alabama income by 55 percent; and over $200 million in royalty payments to itself Abercrombie & Fitch deducted, reducing its income by almost 90 percent.
Combined reporting statutes foil such schemes and the court battles that ensue, by applying a formula to the company’s nationwide revenue that reasonably expresses the percentage of income attributable to a single state.
By Chris McFadyen