The New Mexico Taxation and Revenue Department has upheld an $11.6 million corporate income tax assessment against Wal-Mart Stores Inc., saying the company cannot shield its New Mexico earnings by transferring them to an out-of-state holding company.

The issue has broad-ranging implications for many businesses and centers on how a corporation divvies up earnings between its subsidiary operations and its holding company. In the case of Wal-Mart, the department ruled that the corporation improperly shifted earnings to its Delaware-based holding company WMR Inc., for the sole purpose of reducing income it reported in New Mexico for its in-state stores. Delaware does not assess corporate income tax on its companies, so company earnings that can be attributed to a holding company there are not subject to state corporate income taxes.

That is exactly what Tax and Revenue Attorney Bruce Fort says corporations have been doing for the past two decades or so. He describes a process under New Mexico tax laws by which a corporation can shift its income to a non-taxable fund such as a real estate investment trust, transfer the trust to its holding company out of state, and then convert it back to domestic dividends. Because New Mexico tax law exempts dividends from taxable income, Fort says companies registered in Delaware can easily avoid paying states like New Mexico millions of dollars in taxes.

But Taxation and Revenue says Wal-Mart abused that loophole and owes the state money.

Its decision, handed down on May 1 by a taxation hearing officer, comes at the end of another dispute on a related matter that began in 1997. That year, Kmart Corp. filed a motion in state Appellate Court seeking to overturn a state Tax and Revenue assessment of $1.2 million in unpaid income and gross receipts taxes. The state claimed that the store's holding company, Kmart Properties of Michigan, was collecting licensing fees from K-Mart's New Mexico stores, using the fees to decrease reported income and New Mexico and then not paying state gross receipts taxes on those licensing transactions.

Kmart Properties argued that the license fees paid by its stores in New Mexico were "royalties," making them exempt from state taxes. About one-third of the assessment was what the state said was owed in unpaid gross receipts taxes, while the rest was made up of unpaid income taxes.

In 2001, the appeals court ruled in favor of the state. Kmart appealed and the case languished for nearly four years in the state Supreme Court. In December 2005, the high court let the appeals court ruling stand on corporate income tax, but reversed an earlier ruling on the gross receipts taxes, saying that transactions on intangible properties such as trademarks and licenses occur in the state where the company is registered.

State legislators tightened New Mexico's laws dealing with such matters, say business proponents, by passing a law earlier this year that mandates that such transactions are subject to New Mexico's gross receipts tax, even if the royalties or other payments are made to an out-of-state affiliate or parent company.

New Mexico Rep. Peter Wirth, D-Santa Fe, attempted to close the perceived loophole concerning corporate income taxes during the 2006 legislative session with HB 123. It would have required out-of-state corporations in New Mexico to file combined reports listing all revenue earned by their subsidiaries. That would mean a company such as Wal-Mart would have had to report its entire combined net income as the earnings of a single corporation, and not of numerous subsidiaries operating in different states. All states would then be able to tax a share of those earnings.

Currently, companies can report their earnings as separate corporate entities. So, a company that has significant operations in New Mexico can report very little income when filing as a separate entity, whereas its out-of-state holding company could report earnings from New Mexico as its own. Combined reporting would theoretically eliminate this tax-reporting loophole.

The legislature's fiscal impact report said such a law would have a $60 million recurring benefit to the state by 2007. But the bill was defeated in the House Business and Industry Committee.

Wirth says his combined reporting bill would have used the $60 million in extra corporate income taxes to reduce tax rates by nearly one percent for approximately 15,000 New Mexico businesses. More than 100 other companies, most of them large, national corporations, would have seen their in-state tax liabilities increased by that same $60 million under the bill.

"I find it astonishing various business organizations came out against this bill," Wirth says. "It doesn't seem fair that companies like Wal-Mart can come here and use the loophole to avoid paying their fair share of tax."

Association of Commerce and Industry (ACI) President John Carey defends his organization's opposition to the bill. He says it took a stand against the bill because it was effectively "a tax increase" for a number of ACI's members. Lobbyist Sayuri Yamada says it is the organization's policy not to disclose member's names, adding that most companies don't want their names associated with controversial legislation.

Kmart and Wal-Mart's New Mexico attorney, Tim Van Valen, is an ACI board member and serves on its Legislative Committee. Carey notes that the nonprofit ACI represents numerous small businesses in the state and that none of them came out against the bill.

The Greater Albuquerque Chamber of Commerce says it did not take a position on Wirth's combined reporting bill.

But if the recent ruling against Wal-Mart holds up, Wirth's bill may not be needed, as out-of-state national corporations would be forced to pay corporate income tax in New Mexico the same way that they would if they adopted the bill's proposed combined reporting method for computing earnings.

Van Valen does not know whether his clients intend to appeal any portions of the tax rulings. Wal-Mart had not filed a notice of appeal as of May 17 but has until May 30 to do so.

© 2006 New Mexico Business Journal

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