Reaching for Revenue Offshore, States Push Tax Haven Laws

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By Jennifer McLoughlin

April 11 — States are intensifying efforts to combat corporate tax avoidance amid a slow federal campaign to rein in perceived tax dodgers.

Several state proposals to curb income shifting overseas have surfaced this 2016 legislative session in Kansas, Kentucky, Maine and Minnesota. If enacted, the regimes would add to a body of tax haven legislation in six states and the District of Columbia, all targeting profits held offshore by U.S. companies.

Despite the uptick in legislative activity, detractors continue to dispute claims that taxing income abroad will recover billions in lost state revenue or level the playing field among corporations. Critics are also calling for states to abandon their agendas and defer to federal tax policy.

“The issues surrounding nexus on remote sales might be somewhat different from those surrounding multistate or multinational profits, but they share fundamental commerce and equal protection clause matters,” Pete Sepp, president of the National Taxpayers Union, told Bloomberg BNA in an April 6 e-mail, noting that “it is entirely proper for Congress to establish sensible boundaries on states' ability to enforce tax laws beyond their borders.”

Regulations released April 4 by the U.S. Department of Treasury further target corporate inversions by reducing incentives to incorporate overseas. They already have led Pfizer and Allergan to call off a planned $160 billion merger .

While a step in the right direction, the rules fall short of federal intervention required to shift corporate income back to the states, practitioners say.

“Without comprehensive tax reform, inversions will be a fact of life for U.S. policymakers,” Sepp said. “To borrow a word from President Obama, that is what's really ‘insidious' about our corporate tax system: a narrow-minded focus among too many public officials that we are somehow one small law or rule away from addressing inversions or tax havens.”

Curbing Corporate Shifting

According to MultiState Associates, Inc., 11 states and the District of Columbia introduced 16 bills addressing tax havens in 2015. Connecticut enacted legislation adopting tax haven criteria. The District of Columbia expanded its definition of “tax havens” by adding what many consider a “blacklist” of tax haven countries—but later repealed it .

Tax haven legislation has gathered pace in 2016, with several states looking to reach beyond the water's edge, including:

  • Kansas,
  • Kentucky,
  • Maine, and
  • Minnesota.

    All four states incorporated a list of foreign jurisdictions, continuing the 2015 trend of states favoring the approach that only Montana and Oregon have adopted. However, the Maine Senate had proposed an amendment removing all tax haven language from the bill, and the bill died April 8.

    While most measures ultimately failed last year, practitioners expect the germinating frustration over tax evasion and base erosion will compel more tax haven laws.

    “States typically follow other states in passing tax legislation and this trend seems to be gaining momentum,” said Alysse McLoughlin, a New York-based partner with McDermott Will & Emery, in an April 6 e-mail. “Therefore, I believe the chances are good that at least some new tax haven legislation will pass this year.”

    However, the District of Columbia may serve as a cautionary tale, where “protests from countries that were on the list and from the business community” forced the withdrawal of the blacklist.

    A Colorado bill, targeting income “sheltered in a foreign jurisdiction for purposes of tax avoidance,” has already reached its end. After passing the House, H.B. 1275 died March 28 in a Senate committee.

    “If we keep pressing forward and these type of scandals keep breaking, like the Panama Papers, and people get more and more information about how blatant this tax evasion has become, then I have to believe people eventually will come around,” Rep. Mike Foote (D), a co-sponsor of H.B. 1275, told Bloomberg BNA April 7.

    Published April 4 by the International Consortium of Investigative Journalists, the Panama Papers revealed where some of the most affluent people and entities hide their wealth. Nevada and Wyoming were prominent among the list of tax havens .

    “The principal practical benefit of such legislation is that it provides both tax collectors and taxpayers with a level of certainty as to the tax consequences of foreign investment decisions,” said Stephen M. Cordi, deputy chief financial officer with the D.C. Office of Tax & Revenue, in an April 7 e-mail.

    Data Disputes

    The volume of empirical data substantiating or refuting the need for tax haven legislation is vast and often difficult to reconcile. Practitioners particularly stress the difficulty in quantifying the state-specific impact of corporate profit shifting.

    “There is a high degree of uncertainty surrounding these estimates,” said Matt Gardner, executive director of the Institute on Taxation and Economic Policy, a research organization affiliated with the Citizens for Tax Justice (CTJ). While there are academic studies offering “reasonable ballpark estimates” for the nationwide amount of revenue lost, “there is real difficulty in allocating that between states.”

    A widely cited October 2015 report, co-authored by the U.S. Public Interest Research Group (PIRG) Education Fund and CTJ, estimated that 286 Fortune 500 companies collectively hold $2.1 trillion in overseas profits. A byproduct is that the U.S. Treasury Department loses approximately $90 billion in tax revenue annually, amounting to $620 billion lost overall.

    According to a separate 2014 PIRG study, states reportedly lost roughly $20.7 billion to offshore havens in 2011. The following year, states could have collected an additional $1.68 billion in corporate tax revenue by “closing the water's edge loophole.”

    The State Tax Research Institute (STRI), a research foundation affiliated with the Council On State Taxation, found the estimates—$20.7 billion loss v. $1.68 billion gain—irreconcilable, and has argued that PIRG has never disavowed the earlier estimate or explained the discrepancy.

    However, Phineas Baxandall, a co-author of the PIRG report, explained in an April 7 e-mail that “one source of potential confusion with the data on state taxes lost to offshore tax dodging is that the loophole closing discussed in that paper would prevent only a fraction of that revenue from being lost.” Other factors include:

  • tax evasion by companies that fail to report income “as booked in any jurisdiction;”
  • tax haven lists that don't include all countries that may facilitate tax haven abuse;
  • transfer pricing manipulation; and
  • companies shifting U.S. profits to related entities that are not recognized as subsidiaries or affiliates.

    Analyses are further hampered by a lack of transparency regarding corporate tax liability in other jurisdictions, which “means that figures are necessarily based either on indirect measures or governmental analysis of particular data samples,” Baxandall said.

    Replenishing State Coffers?

    Figures from state taxing agencies show revenue can be recaptured.

    Bob Estabrook, public information officer for the Oregon Department of Revenue, said that the returns for tax year 2014 reported approximately $32.4 billion in tax haven jurisdictions, representing about $9.6 million in state tax income. The DOR expects to pursue additional income through early educational efforts, to advise taxpayers of the new law, and through enforcement efforts later on. According to a 2015 DOR report, the Oregon Legislative Revenue Office estimated that the tax haven law initially would generate over $18 million, eventually reaching $49 million.

    Likewise, a 2012 Department of Revenue memorandum reported that Montana would recover approximately $7.1 million from the top five tax havens. While the numbers have fluctuated on an annual basis, the state has seen steady revenue recovery.

    Montana Department of Revenue Director Mike Kadas takes it “with a grain of salt” when critics claim that tax haven laws don't have a significant impact on the tax base.

    “If in fact their claim that we're not really collecting any revenue was really true, they probably wouldn't be complaining about it,” he said.

    However, the STRI report refutes the extent of states' tax base erosion.

    And approaches other than bright-line blacklists or tax haven criteria, such as combined reporting, have also triggered doubts regarding their capacity for revenue recovery. Sepp observed that the University of Tennessee and others haven't isolated long-term revenue recovery from combined reporting.

    “When it came to the multistate level, apportionment factors (often designed to lower the tax burden of businesses headquartered in the state) made that task of isolation very difficult,” he said. Other complexities contributing to the problem include defining a “unitary group” and the added layers for multinationals, including “treatment of foreign-sourced dividends.”

    Encouraging Equal Footing

    Competing views of the role that tax havens play in local economies pit a level playing field against the agenda of economic development.

    In bringing H.B. 1275, both Foote and co-sponsor Rep. Brittany Pettersen (D) advocated even footing among multinational and local businesses, promoting the policy of “taxes are paid where profits are made” to bolster Colorado's coffers for education funding.

    Gardner views bills that reach beyond the water's edge as a logical extension of combined reporting and a sensible response to corporate tax avoidance.

    “It's always the case that these convoluted offshore loopholes are most available to the large profitable multinationals that have access to a legal team that can construct these things, and that smaller businesses competing with these multinationals just don't have the same access to these tax breaks,” he said. “So, from an economic development perspective, I think the right way to think about it is, not do you want to grab these multinationals by the ankles and shake them upside down,” but rather that the “tax system shouldn't be discriminating against smaller businesses.”

    Foote echoed this concern, saying that without the resources to structure similar tax schemes or lobby government to protect their interests, small business owners remain at a competitive disadvantage.

    Impeding Economic Growth

    On the other hand, critics claim tax haven legislation burdens the U.S. and state economies by deterring business investment.

    “Even more than they do on the federal level, state attempts to put the genie back in the bottle by ‘cracking down' on tax havens often crack the bottle instead and cause the injured genie to flee to someplace else,” Sepp said, referring to General Electric's move from Connecticut as illustrative of corporate departures in response to tax policies .

    With multinational companies, the threat of foreign retaliation also looms large, Sepp added, with the 1980s war over worldwide combined reporting instructive of “the kind of negative blowback that will make revenue problems worse at the state and federal levels, as well as worsen the business climate for FDI and export-intensive businesses.”

    However, Foote said he “begged” but did not receive evidence of economic atrophy from opponents of the Colorado bill. Montana hasn't experienced business backlash, with no complaints from the vast majority of multinational companies, which Kadas attributed in part to the state's “business-friendly tax structure.”

    “When governments and businesses talk about taxes, one of the things everyone almost universally agrees on is that we should have a broad base and a low rate,” Kadas said. “And we're able to have a lower rate because we have the tax haven list. We've broadened our base by doing that.”

    Sticking to Water's Edge

    Unitary combined reporting with a water's edge provision is an alternative tool for narrowing the tax loophole—but isn't without criticism.

    Rhode Island released combined reporting regulations with mandatory water's edge treatment after a tax overhaul in 2014 .

    Likewise, the pending Kansas bill includes a water's edge provision. And the New Jersey Senate has introduced a combined reporting bill with a water's edge election and tax haven criteria .

    “When it comes to states taxing overseas income of multinationals, the water's edge election in theory represents one of the less harmful approaches to ensuring long-term stability of corporate tax systems,” Sepp said. However, he observed that in practice, “any given state's water's edge election can have so many ifs, ands, or buts written into the rules that it looks more like combined reporting to the victim company.”

    Enforcing Economic Nexus

    Another option to combat profit shifting is the concept of economic nexus. Though not directed at multinational companies or foreign affiliates, economic nexus thresholds may capture corporations otherwise not subject to tax liability under the more restrictive federal nexus standard that calls for physical presence.

    Debate over economic nexus standards may be compounded by interpretations of Public Law 86-272, which prohibits states from imposing income tax on the solicitation of sales of tangible personal property.

    McLoughlin, at McDermott Will & Emery, explained that California is of the opinion that Public Law 86-272 doesn't protect companies operating outside the U.S.

    “The more aggressive the states get in imposing economic nexus on foreign companies, the more chance that this will anger foreign countries,” she said, harkening back to California's decision to make worldwide combined reporting optional in response to “pressure from foreign countries and the United States government.”

    At least one state has asserted economic nexus over foreign firms, but ultimately retreated “due to protests from foreign governments,” she added.

    Seeking Stability

    Absent significant congressional action addressing offshore booking of income, practitioners expect that states will continue to pursue tax haven legislation.

    Highlighting “growing distrust of the tools” to shift multinationals' profits overseas, Gardner said that “years after the revelations that Apple and Google and Microsoft have been twisting the international tax system around like a pretzel, I don't think these revelations have lost their capacity to shock.”

    “It has become very easy for multinationals to game the system in a way that is clearly depressing corporate tax revenues nationwide,” he added, observing an increasing urgency as more documentation surfaces to show “just how aggressively multinationals are using offshore tax havens.”

    However, critics find no stability with the mix of state administrative rules and decisions on corporate tax treatment of multinationals, “resulting in massive controversies that can drain companies' resources for years on end.”

    “Elected officials may be reluctant to clarify these matters with actual statutory law, but that's precisely the point—if the tax systems are so complex that they are mostly being run by the un-elected, it is long past time for a massive overhaul of everything from apportionment factors to auditing procedures,” Sepp said.

    Federal Inaction

    Despite the pressure for a federal solution, Congress appears disinclined to intervene.

    The Foreign Account Tax Compliance Act (FATCA), which took effect in 2014, imposes reporting obligations on financial accounts held by U.S. taxpayers or foreign entities with substantial U.S. ownership. Other measures, such as the Stop Tax Haven Abuse Act, have stalled on the Hill.

    While the Treasury Department's recent inversion rules may trigger some reform, practitioners said they probably aren't enough.

    Gardner observed that states “often have a better, greater ability to react in the short run to these problems than the federal government does in practice,” but that results in a patchwork of different approaches that is “clearly second best to a more systematic federal approach” by Congress.

    “You don't have to look beyond the headlines this week to see that really what's happening at this point right now are substitutes for congressional action,” Gardner said, adding that such action seems “very unlikely at this juncture.”

    And should Congress weigh in, it still may not deter states from taking matters into their own hands.

    “Even if the federal government does take action, the states may continue to target perceived corporate income shifting abroad,” McLoughlin said. “Depending upon what action may be taken by the federal government, the states may not believe such action is effective enough.”

    To contact the reporter on this story: Jennifer McLoughlin in Washington at

    To contact the editor responsible for this story: Ryan Tuck at

    For More Information

    A copy of the 2015 PIRG and CTJ Report is at

    A copy of the 2014 PIRG Report is at

    A copy of the State Tax Research Institute Report is at

    A copy of the Montana Department of Revenue memorandum is at

    A copy of the Oregon Department of Revenue report is at .