The term loophole is derived from the Middle English word “loupe,” which refers to a narrow opening in a wall. These slitlike windows were located in medieval castles and provided an observation post and a point to launch projectiles.
Modern-day corporate castles exploit antiquated loopholes to deflect their tax burden on to small businesses. The primary tax avoidance vehicle for corporate behemoths is the Passive Investment Company (or “PIC”) subsidiary. The most infamous PIC is the Delaware tax loophole also referred to as “Geoffrey the Giraffe.” (Geoffrey is the Toys R Us “intangible” holding company.)
Here’s how the scheme works: Under the corporate fiction of the Delaware tax loophole, local outlets of large national chain stores pay royalties to sister companies in other states, claiming the payments as business expenses, and then deduct the “expenses” from their Pennsylvania state income taxes.
“Geoffrey the Giraffe” allows large corporations to pay little state income tax in Pennsylvania. Comcast, Crown Cork, Toys R Us, Wal-Mart and most Marcellus Shale exploration companies are among the corporations that deflect their Pennsylvania income tax contributions through “intangible holding companies.”
However, many states have closed the Delaware loophole. Back in 2004, the governor’s Business Tax Reform Commission released a bipartisan report recommending changes to Pennsylvania’s medieval tax structure. The 12-member commission endorsed numerous measures to level the playing field, including uniform reporting to eliminate the Delaware loophole.
That same year, Maryland officials attempted to collect about $80 million in back taxes, interest and penalties from 72 corporations who used the PIC tax moat. When Maryland abolished the loophole, Philadelphia-based Crown Cork & Seal’s Delaware holding company appealed the legislation. Crown used the Delaware holding company to shelter income earned in Maryland from state taxes.
The Maryland Court of Appeals ruled that Crown could be taxed because it had no real economic substance as a separate business entity. Crown’s appeal to the Supreme Court also was rejected.
For small businesses without interstate operations, the Delaware Loophole is not an option. This tax scam forces small businesses to shoulder a bigger share of the state tax burden. The Department of Revenue reported Pennsylvania taxpayers lost $493 million through this loophole in 2009.
What do passive investment companies look like? Just take a virtual field trip to the top tiers of Rodney Square in Wilmington, Del., and you’ll find the tax-dodging Hall of Fame. The building’s upper floors serve as the “brass plate” headquarters to hundreds of corporations.
How do 700 corporate headquarters squeeze into five narrow floors? How do 500 fit on the 13th floor alone? Frankly, “it’s none of your business,” said Sonja Allen, part of the staff that runs this corporate center for Wilmington Trust Corp, in a 1996 news article.
“Some of my clients are saving over $1 million a month, and all they’ve done is bought the Delaware address,” said Nancy Descano, then holding company chief of CSC Networks outside Wilmington, to a reporter in 1996.
Last February, Reps. Dave Reed (R-Indiana) and Eugene DePasquale (D-York) proposed legislation to require more companies to pay the 9.99 percent corporate net income tax, but also lower the rate to 6.99 percent.
House Bill 1250 would only affect corporations that exploit the Delaware loophole to dodge paying Pennsylvania taxes. Rep. DePasquale stated, “If your presence is in Pennsylvania, then you have to go by Pennsylvania rules. This [bill] is not a tax decrease or a tax increase. In the long term, it makes our state much more business competitive.”
It’s time to close the loupe and fast-track Pennsylvania’s tax laws into modern times. Enacting uniform reporting and eliminating the Delaware loophole is about tax fairness. Legislation to nullify corporate tax-avoidance strategies allows the primary engine of American capitalism — small business — to compete on a level playing field.