VideoToday, nine states have legislation disallowing deductions taken by one company for payments—such as interest, or royalties on patents—to an affiliated company (see "Legislative Disallowance" later in this article). All but two have passed those laws since 2001. After losing the Sherwin-Williams case, Massachusetts simply changed the law last March to allow the tax commissioner to disallow any deduction that he considers a sham. New York passed tougher laws as well, despite winning its fight with Sherwin-Williams. "In 2003, the floodgates opened," says the tax manager of one Fortune 500 company, who requested anonymity. Although only three states—New York, Massachusetts, and Arkansas—passed such laws last year, seven others considered similar proposals. Typically, these laws require the taxpayer to prove that the affiliated company has a legitimate business purpose.
"My prediction is that within the next three years, most separate-return states will have statutory limitations on related company expenses," says COST legislative director Joe Crosby, "and they'll be all over the board, capturing different types of items."
That means more head-aches for corporations. The distinction between aggressive tax planning and improper tax sheltering is already a huge gray area. By disallowing certain types of intercompany transfers, the new laws potentially affect not just tax planning, but also such run-of-the-mill functions as treasury. Many of the new laws allow the company to justify to the tax commissioner why a particular transfer should be acceptable—but that is another compliance burden.
That complaint was already evident in our survey. Asked about the biggest headache for tax directors, one respondent wrote, "Inconsistent treatment of intercompany transactions—will the state disallow the expense, force combination, or declare affiliate nexus?" Said another: "New legislation that unreasonably denies deduction of intercompany payments."
Expensive Butts
What's most worrying about this new legislation, however, is not whether it's reasonable, but that it isn't likely to produce anywhere near enough money. "In the end," says Michael Lippman, head of KPMG LLP's state and local tax practice, "these income-tax expense-disallowance provisions are not going to be the cure for the states' structural deficit problems, because they can't raise sufficient revenue." Despite the emphasis that corporate income tax often gets in the press and in state capitols, it typically makes up just 5 to 10 percent of state tax collections, says Lippman. The real dollars, he says, come from property tax, sales tax, and the individual income tax.
We asked the 81 percent of survey respondents who said tax hikes were inevitable in the state where they work which taxes they'd like to see raised. Many, apparently, are nonsmoking teetotalers, because sin taxes on cigarettes and alcohol were an overwhelmingly popular first choice (41.5 percent). Unfortunately, Lippman notes that most states "already did the easy things" like raising sin taxes. Consumer sales taxes were a strong second among our respondents (35.4 percent), followed by an even split on individual and corporate income tax (16.2 percent each). "With states having exhausted the easy remedies—delaying payment into a pension fund or increasing fees and cigarette taxes—it will be tougher and tougher for them to close the deficit with anything other than a tax increase," says COST's Lindholm
Although some states have already raised taxes—New York, for example, has raised both sales and income taxes—expect a wave of increases after this year's election season. In the meantime, our survey suggests, corporations are going to have to live with tougher tax administration from states seeking to close their budget gaps. "States are out of money, and they are getting money out of audits even when the bases of their arguments are unreasonable, unfounded, and stupid," wrote one survey respondent. "The tax department is then left with the option of fighting them or giving in."
Tim Reason is a senior writer at CFO.
The 2004 Survey Results
This is the fourth time since 1996 that CFO magazine has surveyed corporate tax officials on their impressions of state tax environments. Given looming state deficits, we added questions this year about whether companies expected increased taxes, aggressive clawbacks, or legislation that would withdraw existing business incentives. States that received the worst ranking appear in boxes throughout the text.
An important characteristic of our survey is that it measures opinion, rather than comparing objective measures such as tax rates or appeal deadlines. After our last survey, in 2000, tax officials from some states, including Massachusetts, told us they were disappointed to get no recognition for big improvements in their administrative environment.
Without a doubt, impressions of unfair treatment die hard. States that topped our lists three years ago as most aggressive or least fair are often there again, even though we cast a much wider net this year, sending surveys to some 5,500 corporate tax officials, with the help of KPMG. We received 130 responses, a 2.3 percent response rate. But the results also reflected significant changes to the tax environment—most notably, New Jersey's precipitous drop in the eyes of corporate taxpayers.
Reader Comments» Post a comment