HARRISBURG, March 7 – Legislation introduced earlier this year, claiming to close a much-maligned corporate tax loophole, would not only fail to close the so-called "Delaware Loophole," but would also create new loopholes for corporations to avoid paying their fair share of taxes in Pennsylvania, state Rep. Phyllis Mundy and House Democratic leaders said during a Capitol news conference today.
State Rep. Dave Reed, R-Indiana, introduced House Bill 2150 in January, claiming the proposal would close the Delaware Loophole, which allows multistate corporations to avoid paying the Corporate Net Income Tax in Pennsylvania. Mundy and House Democratic leaders, however, said the Reed bill is just "smoke and mirrors" that does little to bring true tax fairness to Pennsylvania.
"A close inspection of Rep. Reed’s House Bill 2150 shows it is nothing more than window dressing," said Mundy, D-Luzerne. "We can have true tax fairness that will level the playing field, but this bill drops the ball."
Mundy said she is drafting legislation that would close the loophole and cut the Corporate Net Income Tax by 30 percent over six years, beginning in 2014.
Multistate corporations avoid paying Pennsylvania's Corporate Net Income Tax by setting up shell companies in Delaware and certain other states to hold copyrights, patents and trademarks. Multistate corporations that do business in Pennsylvania pay the shell company to use the copyrights, patents and trademarks, reducing its taxable income here.
Companies often use Delaware because it does not tax royalty income. Other states, such as Nevada and Wyoming, do not have a Corporate Income Tax.
The Reed bill would still permit companies to deduct expenses for trademarks, copyrights and patents by simply claiming it is for a legitimate business purpose.
"This creates a new loophole, where companies could easily devise a way to claim a legitimate business purpose in order to avoid paying their fair share of taxes in Pennsylvania," said House Democratic Leader Frank Dermody, D-Allegheny.
Other states with similar legislation require the companies to demonstrate why these deductions are legitimate, but the Reed bill would put the burden of proof on the Pennsylvania Department of Revenue to prove they are not valid. The bill presumes that any of these transactions done at market prices is legitimate.
The Reed bill also would permit multistate corporations to claim a credit for taxes paid in other states and deduct that expense in Pennsylvania. And it allows companies to shift income out of state by deducting interest on loans from related companies, another tax avoidance strategy used by corporations.
Mundy's legislation would require corporations to add back expenses from the use of patents, trademarks and copyrights and interest expenses to their taxable income. It also would set a higher standard for allowing these deductions, and would place the burden of proof on the companies to show the deductions are valid.
She said small businesses in Pennsylvania currently pay a higher tax rate, because more than 70 percent of corporations in Pennsylvania use tax-avoidance schemes, such as the Delaware Loophole, to avoid paying their fair share of taxes. While those multi-state corporations pay zero income taxes, Pennsylvania’s small businesses are shouldering a greater share of the tax burden, Mundy said. That is why her bill would reduce the Corporate Net Income Tax to 6.99 percent from its current level of 9.99 percent.
Mundy, in April, introduced legislation (H.B. 1396) to use the combined reporting method to calculate state business taxes. That bill would close a wide array of corporate tax avoidance schemes, including the Delaware Loophole, by requiring businesses and their subsidiaries to jointly file one tax return and pay taxes according to the amount of business activity conducted in Pennsylvania.
Mundy said combined reporting, which is used by 23 other states, is the best and most comprehensive approach to ensuring that all corporations in Pennsylvania pay their fair share of taxes. However, neither Gov. Tom Corbett nor the GOP-controlled House are interested in that approach.
"If we are going to use the narrower approach to closing the Delaware Loophole laid out by Rep. Reed, then we should at least do it right," Mundy said. "My bill does what Rep. Reed’s bill simply doesn’t: It closes the Delaware Loophole and delivers real tax fairness to Pennsylvania."
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