Two weeks after the Orlando Sentinel reported that at least a hundred ? and potentially far more ? big companies have been reducing their Florida corporate-income taxes through an apparent ?loophole? in state law, the Florida Senate?s chief tax committee plans to take a closer look at the issue.
Tomorrow morning, the Senate Finance and Tax Subcommittee will get a presentation on how multi-state companies use payments between their various subsidiaries to move profits out of Florida ? and away from its 5.5 percent corporate-income tax ? and into corporate-tax-haven states such as Delaware or Nevada.
Exhibit A Circle K Stores Inc., the retailer that owns hundreds of convenience stores across Florida.
Back in 1999, Circle K transferred its name, logo and other intellectual property into a new Delaware holding company, dubbed ?Circle K Enterprises,? which otherwise had no employees or physical property anywhere in the country. Circle K Stores then began paying ?royalties? to Circle K Enterprises for the right to use the trademarks ? and using those payments as the basis for tax deductions in Florida (and, presumably, other corporate-income-tax states).
Records produced in a lawsuit between Circle K and the Florida Department of Revenue show Circle K Stores used the strategy to siphon $56 million in profits out of Florida between 2005 and 2007, saving the company as much as $3 million in state taxes.
Of course, Circle K is hardly alone. Tobacco giant Reynolds American Inc. used? an identical strategy to avoid $4.6 million in Florida income taxes between 2005 and 2008. And Department of Revenue records show that the agency signed audit settlement agreements with another 98 companies doing the same thing between 2000 and 2011. One unidentified company ? presumably far, far larger than Circle K ? was assessed a whopping $46 million in back taxes, penalties and interest, though the amount it actually paid in its settlement deal was a secret.
Other states have identified Wal-Mart Stores, Toys ?R Us, ConAgra , Home Depot and Lane Bryant, among others, of using the strategy.? But the full list of companies ? and their total tax savings ? is impossible to say for sure, because corporate-tax returns are confidential and only become public through litigation.
When other states have challenged this kind of tax-avoidance in court, the fundamental dispute typically boiled down to whether a state could legally tax an entity that had no employees or physical property in that state ? be it Circle K Enterprises or Geoffrey Inc., the name of the Toys ?R Us subsidiary that owned the rights to the toy retailer?s giraffe mascot.
Florida, however, has another problem.
First, some background: To determine how much corporate-income tax a company owes in Florida, you must first determine how much of its profit was earned in Florida. And generally speaking, the way Florida does that is by taking a company?s total U.S. profit and multiplying that figure by a fraction based on the percentage of the company?s sales that occur in Florida vs. everywhere else, the percentage of its employees that work in Florida vs. everywhere else and the percentage of its property that is in Florida vs. everywhere else. This is typically referred to as a company?s ?apportionment factor.?
But in addition to spelling out the formula, Florida?s corporate-income tax laws go into lots of detail about what exactly constitutes a sale, employee or piece of property.
For instance, when the Legislature first enacted a corporate-income tax 42 years ago, it decided that revenue from royalties ? along with revenue from similar types of ?intangible? sources, such as dividends or interest ? should be ignored when deciding what percentage of the company?s sales occurred in Florida. Tax historians say part of the rationale for that was because it could be difficult to decide the geographic location for an intangible sale.
Along with that general rule, the Legislature also made a specific exception. If a company is engaged in the ?production, exploration or development of minerals? ? drilling for oil, mining phosphate, etc. ? then any money it makes from royalties is counted as a sale for the purposes of working out its apportionment factor.
There appear to have been a pair of reasons for this. First, royalties can be a major revenue source for drilling companies, as one company may hold the rights to an oil field but then lease a portion of those rights to another company. And second, it?s not hard to figure out where those royalties were earned ? it?s wherever the oil field is.
(Sidenote: Some tax experts say this generally lowers Florida income taxes for drilling companies, because the vast majority of their royalty income is generated outside of Florida. Counting those royalties as sales can therefore lower their overall apportionment factor in Florida and result in a smaller share of profit that is subject to state tax.)
This is where that Circle K ?loophole? comes in. Because Florida generally excludes royalties from its definition of sales ? but also because it makes a specific exception to that for mineral companies ? then royalties should never be counted as sales for any company that isn?t in the business of extracting minerals.
The result: A trademark holding company like Circle K Enterprises, which had no employees or physical property and earned all of its income through royalties (all of which were paid by other Circle K subsidiaries), did not owe any Florida income tax on its profits. It had no sales, people or property in the state ? at least, not in the way those terms were defined in Florida law.
That?s what Circle K?s lawyers argued in their case against the Florida Department of Revenue. The judge ultimately agreed ? although he also made it clear that ?legal? and ?right? weren?t necessarily the same thing.
?No, I don?t think it?s fair. ? I think these are business activities in the state of Florida,? Circuit Judge Charles A. Francis said during the December 2011 hearing, according to a transcript. But ?the loopholes are loopholes or whatever. And if they?re there and the Legislature doesn?t act to correct it, I think that?s nothing I can do anything about.?
There are a couple of ways to address this issue. One approach is to essentially forbid companies from taking tax deductions based on payments to other corporate subsidiaries. Typically referred to as an ?add back? or ?throw back? rule, it would, for instance, have required Circle K Stores to add back to its taxable income the $56 million in royalty payments it made to Circle K Enterprises.
Another approach, adopted by 22 states around the country, is what?s known as ?combined reporting.? This would require companies to file a single, unified tax return for all of its various subsidiaries ? which would wipe out the impact of any payments between company units. Florida is currently a ?separate return? state, which allows a big company to file different returns for its different subsidiaries.
Both ideas have been pitched in Tallahassee in recent years, by, among other others, Republican state Sen. Thad Altman of Viera and former Senate Minority Leader ? and current Democratic candidate for governor ? Nan Rich of Weston.
But the legislation has repeatedly failed to advance very far, amid opposition from business lobbying-groups such as the Florida Chamber of Commerce and Associated Industries of Florida. For instance, AIF says in its 2013 session priorities that it ?continues to oppose any structural changes to the corporate-income tax such as combined reporting or the throwback rule or any other so-called loophole issues.?
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