TAX NEWS - June 2010

North Carolina tax tussle questions what's fair for companies

North Carolina could lose hundreds of millions of dollars if lawmakers take away the threat of some big penalties against tax-avoiding companies, the state's top tax collector said Wednesday.

Legislation being negotiated in the General Assembly would block the state Revenue Department from slapping the penalties on multistate companies viewed as trying to move profits around the country to avoid paying taxes, Revenue Secretary Kenneth Lay said. A legislative proposal would block penalties of 25 percent for a large tax underpayment and 10 percent for negligence.

"What's the incentive for a corporation not to engage in this behavior if that's what they intend to do?" Lay said.

Meanwhile, individuals or smaller companies who heavily underpay their taxes could still be hit by a 25 percent penalty, he said.

"We would not be treating everyone equally," Lay said.

But Sen. Dan Clodfelter, D-Mecklenburg, said companies now can be surprised by the penalties they didn't know could come. The antitrust and trade lawyer has sponsored the legislation that would peel the power away from Lay's agency. The Senate's version of the state budget includes similar language.

The dispute stems from a state Court of Appeals ruling last May that found Wal-Mart Stores Inc. created a complex corporate structure in which subsidiaries paid rent or dividends to each other primarily to avoid corporate income taxes due to North Carolina.

The three-judge panel also ruled the state tax agency has the authority to combine the finances of multiple subsidiaries in a single return to allow it to determine Wal-Mart's North Carolina tax bill.

The state Revenue Department then launched a special collection effort and in the second half of last year collected $424 million in back taxes from 236 corporations that had previously disputed their tax bills.

News of the higher tax collections cheered lawmakers in January. The sum was nearly $277 million more than the $150 million state leaders had expected to collect and helped avoid employee furloughs and other dramatic belt-tightening imposed last year.

Legislators are counting on the heightened corporate tax collections to bring in another $110 million in the budget year starting next month.

Part of the reason for the flood of new tax revenue was that companies wanted to avoid the big penalties they knew collectors could assess, Lay said. Accounting firms continue pitching large corporations on income-shifting strategies promising big savings on North Carolina tax bills, the Revenue Department said.

But the power tax collectors now wield is unfair, Clodfelter said.

Penalties have been slapped on unpaid tax liabilities recalculated based on combined company operations, even though companies can't calculate taxes that way without direction from the Revenue Department, legislative analysts said in a report.

"Penalties are being assessed retroactively prior to the time you were ordered to file a combined return," Clodfelter said. "This is a highly technical subject. It has gotten spun in a way that is completely off the mark."

Douglas Shackelford, a taxation professor at the University of North Carolina at Chapel Hill's Kenan-Flagler Business School, said he tends to agree with Clodfelter.

"I could understand the logic of why the Department of Revenue would want to have that stick in its arsenal," said Shackelford, a former tax consultant who is not involved in the dispute. "But it seems to me overbearing for a company to be hit with a penalty if they didn't even know they had a liability that would trigger the penalty."