States should close REIT tax loophole that allows corporations to dodge millions in taxes
By Jay Hancock
First published by the Baltimore Sun, February 7, 2007
On May 21, 2003, Wal-Mart transferred ownership of its Ellicott City [Maryland] store to a Delaware-registered affiliate. No money changed hands, legal records show.
Why would the giant retailer go to the trouble of pushing paper in the Howard County courthouse simply to move property from one company to another under the same corporate umbrella?
Pull up a chair and hear the latest tale of tax loopholes, reduced state revenue and really smart lawyers.
As it wrestles with approaching deficits, Maryland may be losing millions in taxes because Wal-Mart and probably other companies have stashed deeds to local real estate in out-of-state affiliates.
By moving property ownership across state lines, Wal-Mart has created a tax-exempt “landlord” that can charge its stores “rent” and deduct the payments from Wal-Mart’s Maryland taxable income. Which reduces its Maryland tax.
It’s a legitimate tax shelter under existing law, says the Maryland comptroller’s office.
But in North Carolina, tax collectors deemed this kind of strategy improper and recovered $25 million in penalties, interest and tax that Wal-Mart had not initially paid over three years, legal documents show.
Wal-Mart, which says its practices comply with the law, is trying to get the money back in court.
In New York, Gov. Eliot Spitzer wants to close a similar loophole said to be costing the state $83 million a year, according to The Wall Street Journal, which reported on Wal-Mart’s “captive” rents last Thursday.
Wal-Mart, which has more than 50 Wal-Mart and Sam’s Club stores in Maryland and just disclosed plans to build three Wal-Mart “supercenters” near Baltimore, isn’t the only company doing this. As usual, however, its size ensures it gets the most attention.
Bank of America is in court with Massachusetts revenue officials over a similar arrangement, the Journal said, and AutoZone has been involved in captive-rent tax disputes in Kentucky and Louisiana.
The auto-parts chain has at least a dozen Maryland stores, and Bank of America has scores of branches.
I called both companies to ask whether they have transferred Maryland property or mortgages (another version of the loophole) to out-of-state tax shelters. Bank of America would not comment. AutoZone didn’t respond to detailed messages.
Wal-Mart’s Ellicott City property and numerous other Maryland Wal-Mart locations are owned by the same Delaware-registered business that collects deductible store rents in North Carolina and other states, property records show.
This company, Wal-Mart Real Estate Business Trust, is organized as a real estate investment trust, which is crucial to the tax savings. REITs are exempt from income tax if they plow most of their profits back to shareholders, which, in this case, is mainly Wal-Mart. (Such “captive REITs” differ from publicly traded real estate trusts, which are owned by numerous shareholders.)
As in North Carolina and other states, Wal-Mart deducts Maryland store rents paid to its Delaware REIT from Maryland taxable income, said company spokesman John Simley.
“We are comfortable with the structure,” he says, adding that there are good reasons beyond taxes to put property in a separate company – to avoid distracting store managers with real estate issues, for example. North Carolina, he says, is the only state that has disputed the setup.
This is similar to the “intangible property” loophole that Maryland closed a few years ago. In that instance, Maryland retailers were deducting “royalties” paid for trademarks owned by Delaware affiliates.
It’s impossible to say how much income-tax revenue Maryland might be losing to captive REITs at Wal-Mart or anywhere else.
Documents from the North Carolina case show that, in 1999 alone, Wal-Mart Real Estate Business Trust collected $2.2 billion in rents from across the country, though it doesn’t break them down by state.
Maryland Comptroller Peter Franchot’s office is prohibited from discussing Wal-Mart or other individual taxpayers, spokesman Joe Shapiro said.
Unlike in North Carolina, there’s nothing Maryland can do to recover taxes lost through captive REITs, he added. State auditors examined the issue a couple years ago “and determined that, within Maryland’s tax structure right now, that is a [legitimate] tax shelter,” Shapiro said.
That means it’s up to the General Assembly to change it.
A simple law will close the loophole. And, as luck would have it, there’s a model. See House Bill 1581 from the 2005 session, introduced by Del. Sheila E. Hixson, a Montgomery County Democrat who is chair of the House Ways and Means Committee.
The bill, which would close the captive-rent loophole, went nowhere two years ago. Hixson should revive it to boost state revenue and stop a practice — companies saving taxes by paying rent to themselves — that flunks the common-sense test.
© 2007 Baltimore Sun
Related feature: Wal-Mart’s State Tax Evasion Ploy: Paying Rent to Itself (Wall St. Journal)