Two years ago, the Wall Street Journal ran a story revealing that Wal-Mart pays billions of dollars a year in rent for its stores, but in 25 states — most of them east of the Mississippi — it has been paying most of that rent to itself, and deducting that amount from its state taxes. By so doing, Wal-Mart has avoided paying several hundred million dollars in state taxes. Based on a scheme developed by its accounting firm, Ernst & Young, for a “local tax reduction strategy,” Wal-Mart’s financial self-dealing allows it to pay rent to itself through a maze of eight corporate subsidiaries created in November of 1996, including Real Estate Investment Trusts (REITs). The rent appears as an expense on state tax forms, and is thus deducted from its taxable revenues. Under the agreement with itself, Wal-Mart pays 2.5% of gross sales monthly as rent to its own REIT, which then wires the money quarterly to Wal-Mart Property Company in the form of a dividend, which is then paid to Wal-Mart Stores as a tax-exempt “dividends received.” All of these transactions are handled through a “cash management agreement” between all the parties. Neither the REIT nor the Property Company ever had any employees. The REITs don’t pay taxes, as long as they pay 90% of their income out in dividends to shareholders. In Wal-Mart’s case, the REITs are owned by Wal-Mart subsidiaries registered in Delaware, a state that has no corporate income tax. Wal-Mart gets the benefit of the rent expense, but also gets the benefit of the non-taxed dividend, on the same monies. The dividends escape taxation, and the original rent that created the dividends is deducted from taxable income in the states where the “expense” is incurred. The rent, in essence, goes from one Wal-Mart pocket, into another. This strategy has been used by Wal-Mart for 12 years. But the state of North Carolina challenged the tax dodge several years ago, and disallowed the rental deduction from its taxable income for the period 1999 to 2002. North Carolina insisted that Wal-Mart submit “combined returns” for Wal-Mart Stores East, Wal-Mart REIT, and Wal-Mart Property Company. The state argued that Wal-Mart was “distorting its true net income.” It charged that Wal-Mart Stores East owned all the stock of Wal-Mart Property Company, which owned a majority of the shares of Wal-Mart REIT. Wal-Mart paid the bill, but then sued the state’s Secretary of Revenue, Reginald Hinton, in 2006, charging that it did not owe the higher taxes, because North Carolina did not have the right to consolidate its expenses in North Carolina with its subsidiaries in Delaware. After the lawsuit was filed, both sides asked the court for a Summary Judgment, which is a decision made on the basis of statements and evidence presented for the record without a trial. It is used when there is no dispute as to the facts of the case, and one party is entitled to judgment as a matter of law. On December 31, 2007 an Emergency Special Judge in Wade County, North Carolina Superior Court, ruled in favor of the state of North Carolina, and against Wal-Mart’s lawsuit. The Judge ruled that North Carolina had the statutory right to force a corporation to state its “true net income” through a consolidated statement, “so as to properly reflect the extent of the corporation’s activities in the state.” Judge Clarence E. Horton ruled that Wal-Mart’s treatment of rent had no “real economic substance,” and was only a mechanism for reducing the taxes it pays to the state of North Carolina. Wal-Mart was seeking a $30 million refund in taxes for its Wal-Mart stores, and $3.5 million for Sam’s Club, including interest and penalties, based on what state officials had charged the company after disallowing its rental deduction. The Wall Street Journal estimated that this tax avoidance scheme saved Wal-Mart $230 million over a four year period. “Plaintiffs do not deny the facts demonstrating the circular journey taken by the ‘rents’ paid by these plaintiffs,” Judge Horton said, “but contend that on each leg of the journey plaintiffs were only taking advantage of a lawful deduction afforded them by then-existing tax law. Such a piecemeal approach exalts form over substance, however… There is no 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.” Wal-Mart appealed the Wade County Superior Court ruling, and on May 19th, the North Carolina Court of Appeals denied Wal-Mart’s attempt to get a $33 million tax refund. According to the Associated Press, the three-judge panel voted unanimously that the state has the authority to combine the finances of subsidiaries for the purpose of calculating a company’s state tax bill. “The language of the statute is broad,” the court ruled, “allowing the secretary (of revenue) to require combined reporting if he finds as a fact that a report by a corporation does not disclose the true earnings of the corporation on its business carried on in this state.” Wal-Mart told the AP that its quest for a tax refund is not necessarily over. “We feel all taxpayers should be able to rely on clearly defined laws that are reasonably and fairly enforced,” a spokeswoman for the retailer said. The court also decided it was fair to charge Wal-Mart for the interest and penalties that North Carolina included with Wal-Mart’s tax bill.
Wal-Mart has also been burned on this tax scheme in Wisconsin. According to Wal-Mart, they paid more than $26.2 million in state and local taxes in the state of Wisconsin in FYE 2007. Unfortunately, the state of Wisconsin did not agree with that figure, and is charging that the world’s richest retailer owes the state millions in back taxes. On April 18, 2007, Sprawl-Busters reported on research by the Citizens for Tax Justice (CTJ) which found that across the nation, Wal-Mart avoided $2.3 billion in state income taxes from 1999-2005. According to CTJ, by using an array of tax loopholes, such as the REITs, Wal-Mart paid less than half of the state income tax that would be expected. In Wisconsin, on estimated income of $852 million from 2000 to 2003, Wal-Mart paid only $3 million in state income tax — a tax rate of 0.35% versus the 7.9% statutory tax rate corporations are supposed to pay in Wisconsin. “In effect, Wal-Mart pays rent to itself and takes a deduction for doing so,” according to the Wisconsin Revenue Department claim. The REIT pays the rent as part of a dividend to the parent company. The dividend is tax-free under state and federal law. The state Revenue Department says that Wal-Mart set up these subsidiaries for the sole purpose of avoiding taxes, and on that basis disallowed the deduction as illegal, and now wants Wal-Mart to pay its bills — which prompted Wal-Mart to challenge the state’s ruling. State officials in Wisconsin charge that by using this mechanism, Wal-Mart has dodged millions in tax payments by paying rent on 87 Wisconsin properties. The Wisconsin Department of Revenue called Wal-Mart’s actions an “abuse and distortion of income.” The Arkansas-based retailer now owes the taxpayers of Wisconsin $17.7 million in corporate taxes and interest just for the years 1998, 1999, and 2000, according to the Milwaukee Journal Sentinel. Figures for more recent years have not been made public. Wisconsin Revenue Department lawyers told the newspaper that because Wal-Mart has not been paying its fair share of taxes, it has been hurting the public schools, local police and fire departments and the highways the company uses in the process of doing business in the state. Because Wal-Mart doesn’t pay its fair share, other individual taxpayers and small businesses in the state have to assume an unfair burden. These other taxpayers, the state said, are not wealthy corporations who are able to set up “elaborate mechanisms,” to avoid paying taxes. The state’s Tax Appeals Commission was hearing the case. “Anything Wal-Mart can do to lawfully lower its costs allows the company to pass it along through lower prices,” a company spokesman told the Milwaukee Journal Sentinel. “This is a lawful (tax) structure in Wisconsin.” It can also be argued that Wal-Mart did not “pass it along” to consumers, but pocketed the difference as part of its $12.7 billion in profits last year. The Wal-Mart “tax deadbeat” story has forced some state lawmakers in Wisconsin to propose language in the state’s budget that would outlaw the “abusive” tax scheme that Wal-Mart apparently still uses to avoid paying taxes. State Senator Russ Decker (D-Schofield), said Wal-Mart and others who use the deduction are “scamming the system, and we ought to plug the loophole.” Senate Majority Leader Judy Robson (D-Beloit) accused Wal-Mart of being the “poster child” for corporations that don’t pay their fair share of taxes. Other competitive retailers in Wisconsin, like Sears and Kohl’s, told the newspaper they do not use the “captive REIT” technique to avoid state taxes.. Wal-Mart is Wisconsin’s largest private employer, with 28,920 workers. If the Tax Appeals Commission comes down against Wal-Mart, the retailer is expected to take its case to court, which means Wisconsin taxpayers aren’t going to see any relief from Wal-Mart for many years to come. “It’s just a fairness issue,” one State Senator told the Journal Sentinel. “Go down on Main Street – these businesses are being economically disadvantaged to these big corporations.” This past year, the state of Massachusetts closed this tax loophole by adopting “combined reporting” tax reform, which requires corporations to report all their revenues in one state, ending the ability to assign costs to other states and escape taxation. All related companies will have to file one income tax return. In Massachusetts, Wal-Mart says it paid nearly $19 million in state and local taxes in 2006. Assuming roughly $11 million of that was state income tax, the retailer also avoided $5.4 million by deducting rent it paid to its Delaware-based REIT as a business expense, lowering its taxable income. The company also cost Massachusetts taxpayers $7.2 million in health care costs for 6,000 Wal-Mart workers and dependents on Medicaid. The net result is that Massachusetts taxpayers actually lost money on the 45 Wal-Mart stores in their state. Massachusetts Governor Deval Patrick filed the legislation that closed Wal-Mart’s loophole in the Commonwealth. Wal-Mart maintains that it is only taking advantage of a lawful deduction afforded by then-existing tax law. But the North Carolina Court has referred to this corporate behavior as a “circular journey” of money. “Such a piecemeal approach exalts form over substance,” the superior court wrote. Most Wal-Mart customers are also taxpayers, and the retailer’s elaborate efforts to avoid paying taxes, robs each of its taxpaying customers of revenue that could have been used to educate children, pave roads, or bolster local aid for police and fire services. Wal-Mart argues that it passed these cost savings onto its customers. But the reality is, Wal-Mart the tax deadbeat, passed these costs onto its unsuspecting customers by not paying its fair share of state taxes. This North Carolina decision is likely to have legal implications across the country, because Wal-Mart has used the methodology for more than a decade in so many other states. Wal-Mart now has the option to appeal this decision to the North Carolina Supreme Court. The retailer’s litigation mantra seems to be: “Never take No for an answer.”