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(Excerpt from the Wall Street Journal...)

Abstract:
Company pays rent to itself, and then writes-off the "expense" as a tax-deduction.

"Wal-Mart could deduct from its state-taxable income the rent paid by Wal-Mart Stores East to the REIT. The REIT paid the majority of its rental earnings to its 99% owner, Wal-Mart Property Co., in the form of dividends. That company's base in Delaware gave it another way to avoid liability for state taxes, since some states do require that dividends a REIT pays to its corporate owner be taxed, as the federal government does.

The Delaware subsidiary then paid the money back to Wal-Mart Stores East, the same subsidiary that made the payments to the REIT to begin with. Those payments to Wal-Mart Stores East weren't taxed either, because dividends paid to a corporation by a subsidiary normally aren't counted as taxable income for the parent company.

The result of the circuitous transaction: Wal-Mart could effectively turn rental payments to itself into state level tax-deductions in most of the states where the payments have been made. Under typical circumstances, rent paid to a third-party landlord also would reduce taxable income. But that would ordinarily be cash out the door, like most other tax-deductible expenses. Here, the majority of the tax-deductible rental payments came straight back to Wal-Mart.

The national tax savings have been significant. Over a four-year period, from 1998 to 2001, Wal-Mart and Sam's Club paid company-controlled REITs a total of $7.27 billion that eventually came back to Wal-Mart in states across the country, according to a North Carolina Department of Revenue auditor's report filed in court by Wal-Mart. Based on an average state corporate income tax rate of 6.5%, three accounting experts consulted by The Wall Street Journal estimated the REIT payments led to a state tax savings for Wal-Mart of roughly $350 million over just those four years. SEC filings show the company paid $1.18 billion in state taxes during that period. The loss of federal deductions that bigger state tax payments would have triggered brought the company's effective tax savings overall down to about $230 million. Wal-Mart declined to comment on the figures."

Comments

( 1 comment — Leave a comment )
notebuyer
Feb. 5th, 2007 03:40 pm (UTC)
I used to practice tax law, before I made my living arranging financing for commercial buildings.

The deal looks like it could be attacked as a "step transaction" if there is no diversity of ownership of the REIT: but if there is, it probably stands.

A group of young lawyers took out an older lawyer at an ABA function, and he had something to pass on: "America has two models of law. First, we have the Constitution, which in five short pages lays out the whole structure of the federal government and its relationship to the states. Every year we have cases coming up to the courts asserting that it is ambiguous, doesn't cover X case, or whatever. Unending litigation.

"On the other end of the spectrum, we have the Internal Revenue Code, which in clause after clause carefully lays out the structure of taxation, and has official revenue rulings, advisories, and bulletins about the meaning and effect of its provisions. And there are so many tax cases that a separate court has been set up to try and take the load off the courts estabilshed by Congress to handle all the rest of federal litigation.

"There's a simple moral here: there is no document we lawyers draft that is free of ambiguity. We can try and press it around a little here and there, but we can't remove it."

It was a worthwhile dinner. The moral was a reminder that the legislation will inevitably have to cover situations that its drafters didn't even think about, and what happens then isn't obvious. We have a country full of very creative people, who want to do new things, and who generally don't put up with laws that say, "This is the only way you may do it." And for good reason.
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