One Company’s Plan to - Save Money, Live Better Wal-Mart’s State Tax Avoidance Schemes
Loopholes Schemes vary by state Wal-Mart only paid half the state rates for the last 10 years Strategies have saved Wal- Mart hundreds of millions in state taxes
Real Estate Investment Trust Originally created by Congress in 60s intended to protect small investors Not subject to corporate income tax 90% pay-out as dividends
Captive? Pitched by Ernst & Young in mid 90s Detailed corporate restructuring Create captive REIT Real estate investment trust 50% voting power/value controlled by single corporation
The Formula Parent Company Tax Break No State Receives on REIT Taxes Subsidiary Dividends Dividends Tax Free
Wisconsin in the Limelight Fiscal Years 2000-2003 $852 million net profit $3 million corporate income tax Tax rate of .35% WI has 7.9 % income tax rate
Before Ernst & Young Trademark Holding Company (THC) transfer trademarks, trade names and service marks license marks back to original company Louisiana assessed $15.4 million in back taxes under this scheme New Mexico assessed Wal-Mart $11.6 million in 2006 Hearing officer noted WMR was created “for the primary purpose of reducing state income taxes for Wal-Mart Stores, Inc.”
Restructuring Mid-90s corporate overhaul 8 new subsidiaries, including Wal-Mart Stores East, Inc Wal-Mart Property Company Wal-Mart Real Estate Business Trust (Wal-Mart’s captive REIT)
Following Restructuring Transfer property ownership to REIT Land and stores In 27 states Non-unitary or separate entity states only Do not require combined tax return
The Money Circle All parties owned by Wal-Mart Money wired through- out company Turns rent into tax deduction
The Role of Ernst & Young Originally pitched to banks Solely as method to reduce taxes Q: What’s the business purpose? A: Reduction in state and local taxes. Q: What if the press gets wind of this and portrays us as a “tax cheat”? A: That’s a possibility...If you are concerned about possible negative publicity, you can counter it by reinvesting the savings in the community. -from E&Y sales packages
E&Y’s Assurances Wal-Mart Vice President of Tax David Bullington Received 25 page memo in 1997 Outlines likelihood of state taxation of REITS REITS receive favorable tax treatment Rent as non-arbitrary shifting of income Express viable business and legal reasons State-by-state success analysis
E&Y Virginia Analysis
Silence Recommended “We don’t think there is much the state taxing authorities can do to mitigate those savings to Wal-Mart, however some states might attempt something if they had advance notification. We think the best course of action is to keep the project relatively quiet.”* *Memorandum from Ernst & Young to Wal-Mart Stores, Inc. regarding “Wal-Mart State Tax Project.” April 30, 1996.
Business Reasons Vice President of Tax David Bullington pleads: Centralizing Payroll Licensing and Real Estate Functions Creating an organizational structure representative of how they want to manage the business Protecting officers, directors and shareholders from litigation And yet “No studies have been conducted....to quantify the consequences of the reorganization.”
North Carolina Assessment April 2, 2002 - Department of Revenue began an audit In 2005 Wal-Mart filed combined returns for 1999-2002 Paid $33 million Wal-Mart sued the state for refund in 2007 Department of Revenue defended the assessment Income tax returns did not show “true” earnings Method of accounting did not reflect income Business conducted to distort “true net” income
Court Decision Superior Court Judge Clarence E. Horton Jr. ruled “There is not evidence that the rent transaction, taken as a whole, has any real economic substance apart from its beneficial effect on plaintiffs’ North Carolina tax liability. It is particularly difficult for the court to conclude that rents were actually ‘paid,’ when they are subsequently returned to the payor corporation.”
Wisconsin Assessment Wisconsin files notice of field audit, June 2002 Method of paying rent on 87 WI properties Considered “abuse and distortion of income” Alleged $18 million in back taxes plus interest and penalties 1998 - 2000
Legal Overview New Mexico, Tax Hearing Officer “The trademark holding company was created for the primary purpose of reducing state income taxes.” North Carolina, Judge Horton “There is no evidence that the rent transaction, taken as a whole, has any real economic substance apart from its beneficial effect on plaintiff’s North Carolina tax liability” Wisconsin, Department of Revenue “[The] abuse and distortion of income...is plainly intended for no purpose other than tax avoidance.”
Italian Subsidiary 2007, Illinois issued a $21 million Notice of Deficiency WMGS Services, subsidiary of Wal-Mart Property Company, created in 2001 Small office in Turin only operating unit of WMGS Controls billions in Wal-Mart property 80/20 - domestic subsidiary conducts 80% of business overseas “Foreign” operations tax exempt
Avoiding Combined Reporting Illinois uses combined apportionment method Requires inclusion of REIT income on tax return Unlike NC and WI REIT methods no good Foreign 80/20 subsidiaries excluded from unitary group
Payment Under Protest Wal-Mart paid $26.4 million assessment in Illinois “Under Protest” Director of Illinois Department of Revenue, Brian Hamer Misuse of 80/20 company “shocking to the conscience” “These kinds of manipulations clearly were never contemplated by the state legislatures...It ought to have been clear to business that this was highly questionable conduct.”
Corporate Owned Life Insurance Initially for executives - “key man insurance” COLI for associates pitched as tax benefit in 1993 Policyholder pays substantial premium for 3 years Borrow back at high interest rate Interest payments tax deductible When insured dies, company receives payout
Wal-Mart COLI Program 350,000 enrolled between 1993 and 1995 All employees age 18-70 Participating in company benefit program Corporation Grantor Trust established in Georgia Guarantees “insurable interest” in all employees Wal-Mart admits intent to reduce income taxes Pleads need to offset rising health care costs
Federal Government Intervenes 1996 Congressional legislation effectively ends COLI tax benefits IRS challenged pre-1996 COLI tax deductions Wal-Mart settled with IRS in 2002 Suffered significant tax liability Wal-Mart canceled policies in 2000
Wal-Mart COLI Litigation Lost Texas class action in 2004 no “insurable interest” in lives of hourly employees Settled Oklahoma class action in 2005 for $5 million Employees did not benefit or consent Florida men seeking class action status in COLI case Claim Wal-Mart made $9.6 million on 135 deaths Wal-Mart suing insurance company for loss of tax benefit
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