Research center: Delaware loophole proposal falls shortJason Scott
A bipartisan reform package that would close corporate tax loopholes has the right idea, but is not the right approach, according to a new report from the Harrisburg-based Pennsylvania Budget and Policy Center, a nonpartisan research center.
Supported by House Republican leadership and co-sponsored by York County Democratic Rep. Eugene DePasquale, House Bill 2150 would add an "expense add-back provision" to prevent corporations from reducing or avoiding taxes through the so-called "Delaware loophole," beginning in 2013.
Currently, multistate corporations can reduce their Pennsylvania taxes by reporting their income and profits through affiliates in other states, primarily Delaware.
The Delaware loophole enables businesses to avoid paying the 9.9 percent corporate net income tax, the highest flat rate in the nation, while small state-based companies that don't have shell companies are forced to carry more of the tax burden along with individual taxpayers.
To further combat the problem, the bill calls for the reduction of the corporate net income tax to 6.9 percent in 0.5-percentage point increments over six years, beginning in 2014.
"Voters are weary of tax loopholes and they are wary of excuses that are made for not closing them," Sharon Ward, director of the center, said in a news release.
Across the U.S., 35 of the 45 states with corporate taxes have taken steps to close corporate tax loopholes by enacting combined reporting or adopting expenses add-back laws.
Fees, royalties and other transactions between related companies would be added back to the companies' income and taxed, according to HB 2150.
The center's report cites several flaws with the bill:
- It would offer overly broad deduction allowances for royalty and other intangible expenses, allowing any expense related to a valid purpose, even if the primary purpose is tax avoidance.
- The bill presumes that any transaction equal to market prices is for a valid business purpose, making it very easy to secure an exemption to the rule.
- It creates a new loophole allowing some companies to get double tax benefits. A company would be able to get a credit for taxes paid by an affiliate on income even when it is allowed to take the deduction of the royalty expense in Pennsylvania.
- The bill permits companies to deduct interest payments made on loans from a related company — something that few of the dozen or so states that have adopted add-back laws allow.
The report recommends that lawmakers drop the corporate tax rate cut and other breaks for business in the bill because the state can "ill afford them at this time."
Pennsylvania tax revenue remains nearly $482 million, or 3 percent, below the 2011-12 budget projection, according to a recent report from the state Department of Revenue.
The center recommended a bill that would be modeled after one drafted by the Multistate Tax Commission, a group of state tax agency officials. It would require both intangible expenses (like royalties) and interest payments to be added back to a company's income and set clear standards for allowing legitimate interest and intangible expense deductions by a corporation.
The model bill also ensures a company isn't taxed twice, but doesn't allow it to double dip on deductions, the report said. The center supports a combined reporting approach.
Under combined reporting, companies pay taxes based on the combined activities of all their subsidiaries.
House Bill 1396, a bill sponsored by a Luzerne County Democrat, would do exactly that. House Democrats are planning to introduce a new proposal to address the corporate tax structure later this month, said Bill Patton, a caucus spokesman.