North Carolina’s state Senate has gone to bat for big business by voting to eliminate an important incentive for companies to pay their fair share of corporate income taxes.
North Carolina remains in the minority of states that levy corporate income taxes but do not require corporations to file a combined tax return for all of their affiliates, a requirement called "combined reporting" by policymakers. The lack of combined reporting leaves the state vulnerable to various income shifting strategies used by large, multi-state corporations. However, since 1941, North Carolina’s Department of Revenue (DOR) has had the authority to (at its discretion) force affiliated corporations to file combined returns. In recent years, due to major court decisions affirming this authority and engaged leaders at the DOR, they have used this power aggressively, and successfully, to seek out corporate tax dodgers and hold them accountable for the true tax they owe.
Last year alone, DOR’s ramped up corporate tax compliance efforts brought in more than $400 million ($150 million was budgeted) and the governor, Senate, and House’s FY10-11 budget proposals are counting on DOR to bring in another $110 million this year.
But the North Carolina Senate’s budget proposal also strips DOR of another tool that has allowed for their success, the 25 percent “large tax deficiency” penalty. The penalty works like this: If the new tax liability determined from combining returns is more than 25% of the original tax paid, corporations may have to pay a penalty equal to 25% of the difference on top of the new tax they owe.
North Carolina’s Revenue Secretary, Ken Lay, says that without this penalty, multi-state corporations would continue to engage in tax avoidance strategies, playing the “audit lottery” and taking a chance on hiding their income. The DOR uses the penalty to incentivize companies that owe back taxes to settle quickly and, as a reward for doing the right thing, DOR will waive the penalty.
They need this “stick” because without it their compliance efforts will fail to produce meaningful results and certainly will not yield the $110 million budgeted for collecting unpaid taxes.
Whether or not to strip this authority is at the center of North Carolina’s final budget negotiations between the Senate and House. The provision was not included in the House’s budget proposal.
Sen. Dan Clodfelter, a Democrat and chair of the Senate’s finance committee, is leading the charge against DOR. He thinks removing the penalty is “only fair” because businesses should not be punished for not anticipating a DOR audit that would result in different tax liability from a combined versus separate entity reporting practice. Other proponents claim that those forced to pay the penalty were “well-intentioned” and “had no way of knowing the department would disagree with its tax return years later.”
Secretary Lay disagrees and says that DOR focuses on pursuing cases in which businesses are believed to be intentionally hiding income through complex tax avoidance schemes commonly used by large, multi-state corporations. When DOR determines a corporation did not purposefully abuse its separate entity filing status to hide income, the penalty is waived.
With few exceptions, big corporations are fully aware when they're dodging their tax responsibility. They frequently hire large accounting firms who tout tax avoidance schemes and promise them substantial tax savings. And in two recent high-profile court cases in North Carolina against Wal-Mart and Food Lion, the evidence was clear that the two companies restructured their operations with the intention to reduce their taxes in the state and elsewhere.
Even North Carolina’s major newspapers have joined this debate on what would seem to be an unusually technical issue. Sen. Clodfelter’s hometown paper called the Senate’s proposal to “ease corporate taxes” a” bad idea” and the Raleigh News and Observer suggested big businesses’ campaign contributions may be behind the Senate’s efforts to eliminate “tax enforcement policies that are both fair and rigorous.”
As the North Carolina Budget and Tax Center recommends, the obvious solution to address Sen. Clodfelter’s concerns would be to enact mandatory combined reporting. Mandatory combined reporting would not only prevent tax-dodging and level the playing field between large, multi-state corporations and smaller, in-state businesses, but it would also offer clear guidance on the correct way to report income and business activity that occurred in North Carolina.