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Sunday, October 18, 2009

'Combined Reporting' Unfair

By Dick Minzner
Albuquerque Attorney
          There has been discussion of making "combined reporting" of corporate income taxes mandatory in New Mexico. Advocates claim it will raise tax revenues and prevent corporations from using a supposed loophole to avoid New Mexico taxation by shifting to other states income that was earned in New Mexico.
        Combined reporting would be harmful to economic development because it would impose substantial tax obligations on successful businesses simply for establishing New Mexico subsidiaries.
        Currently, corporations that are members of corporate families (parent and subsidiary corporations) may choose to report on a "separate" or "combined" basis. Separate reporting requires corporations doing business in New Mexico to pay corporate income tax on the income they earn in New Mexico.
        Combined reporting requires corporate families with any member in New Mexico to pay income tax based on the total income that all members of the corporate family in the same line of business earn nationwide. A part of that total income is apportioned to New Mexico by formula, without regard to whether it was earned by a company doing business in New Mexico.
        Important information has been omitted from the discussion of this issue:
        • Combined reporting is not principally a device to tax income earned in New Mexico and shifted out of state.
        Rather than a device to tax income earned in New Mexico, combined reporting is principally a device to capture and tax a portion of income earned in other states by corporations not doing business in New Mexico. Combined reporting requires the reporting of all the income of all the affiliated corporations within a corporate family, whether or not it was "shifted" from one state to another. This means that a profitable corporate family setting up a new New Mexico subsidiary would immediately owe New Mexico corporate income tax based on the profits earned by other subsidiaries in other states, regardless of how its New Mexico operations performed.
        • Combined reporting is not the most direct way to prohibit inappropriate income-shifting.
        Some transactions between members of a corporate family increase the income of one member and decrease the income of another. For example, leasing assets from one member to another, or paying interest on a loan, produces a deduction for the paying company and income for the receiving company. Many of these transactions may be for valid business reasons, but some may be for tax avoidance. Most separate reporting states, but not New Mexico, have passed "add back" statutes to eliminate the tax effect of such transactions in certain cases. To prevent the shifting of income it regards as illegitimate, New Mexico could pass such "add back" legislation.
        • Combined reporting will not produce much money.
        Advocates have suggested that combined reporting might produce annual state revenues of $40 million to $100 million. These estimates are based on outdated information. A more realistic current estimate might be approximately $25 million, perhaps less. (By way of comparison, a one-quarter percent gross receipts tax increase produces well over $100 million.)
        • The current corporate income tax system is not unfair to small local businesses.
        Most small businesses pay no corporate income tax or similar tax because they are organized as partnerships or sole proprietorships. If they are organized as corporations, the principal owners are likely also to be employees, and they can effectively eliminate all taxable corporate income by paying it to themselves as salaries or bonuses. Finally, there are reduced tax rates on the first $1 million of taxable net income.
        • Businesses have not recently received substantial tax cuts.
        Most of New Mexico's recent tax cuts benefit individuals, not businesses. There have been personal income tax reductions, including capital gains tax reductions, totaling about $400 million annually. The removal of the gross receipts tax from food cost the state about $200 million annually. Substantial tax incentives for specific industries have been passed and tax increases on specific industries of similar amounts also have been adopted. Most businesses suffered a tax increase when the state gross receipts tax, which both businesses and consumers pay, was raised by one-half percent within the cities, concurrently with the elimination of the tax on food. This tax increase totaled about $170 million, a portion of which fell on businesses.
        Mandatory combined reporting would be an unjustified tax increase which would have a negative impact on economic development in New Mexico without any substantial benefit to the state.
        Dick Minzner is a legislative lobbyist who represents a behavioral health provider and a renewable energy company which oppose combined reporting. He also is a former secretary of the New Mexico Department of Taxation and Revenue and chaired the Taxation and Revenue committee overseeing the department during his tenure in the state House.