Arkansas is losing millions in state corporate income taxes every year because of holes in our corporate tax laws. In particular, we lack a “combined reporting” law that would help ensure that large companies pay their fair share of taxes on the profits earned in Arkansas. Corporate tax avoidance is costing Arkansas an estimated $44 to $88 million a year. The millions in lost corporate tax revenue cost the state budget. This means either reduced funding for programs that promote a healthy and well- educated workforce and the infrastructure that is important to state economic development.  It also means that other taxpayers, such as low and middle-income taxpayers or small businesses, have to pay more in taxes to make up the difference.   This puts small businesses at a competitive economic disadvantage with their much larger, multi-state corporate competitors.

Fifty-seven (57) percent of Arkansas corporations (17,403) paid zero corporate income tax in 2012. While some of these corporations had legitimate reasons for paying no income taxes (such as they failed to earn any profits), others undoubtedly paid no taxes because of the lack of combined reporting.

Without combined reporting, multistate corporations can avoid Arkansas taxes by shifting their Arkansas profits, at least on paper, to their subsidiaries in other states that have lower or no corporate income taxes. Combined reporting helps prevent parent companies from hiding profits by requiring them and their subsidiaries to report their profits and file their taxes as one unit.

If a company operates in more than one state with different corporate tax rates, which tax rate does it pay? Most states try to deal with this problem by estimating what portion of a company’s profits came from each state, and taxing based on their “share” of the profits. This method is called “apportionment” and takes into account the total sales, payroll and property the company has in each state. Arkansas’ apportionment formula is supposed to ensure that if profits are made in Arkansas, then those profits are taxed based on Arkansas rates. That sounds reasonable, but there is a major problem with Arkansas corporate tax law; companies and their subsidiaries file taxes separately. Despite technically following apportionment laws, the lack of combined reporting  allows  large, multistate Arkansas based corporations to shift their Arkansas profits to other states and pay little lower or no corporate incomes taxes.

Multistate corporations can avoid state taxes even if they follow apportionment laws by sheltering profits in states with lower taxes. Most large multistate corporations are structured like families, with a large parent organization and smaller subsidiaries underneath. A company can make profits in every state, but by moving those profits to a subsidiary in a low-tax state, like Delaware, they can avoid paying any taxes at all. Apportionment is irrelevant in this case because there are no profits for the parent company to pay taxes on. Subsidiaries and parent companies pay taxes separately but are still part of the same organization. So, shifting profits to a subsidiary in another state is equivalent to renting out a house to yourself; the rent money might go to a different bank account, but it’s still your money. Many companies create subsidiaries in states without corporate taxes for the sole purpose of transferring profits.

One of the most well-known examples of corporate tax loophole exploitation was by Toys-R-Us. Toys-R-Us was making profits in stores across the country, but wasn’t paying full corporate taxes on those profits. The company created a subsidiary in Delaware that held the rights to the company’s mascot “Geoffrey”. The retail stores had almost zero profits because all of the money went to pay for royalty fees for the right to use the image and name of Geoffrey. Overall, of course, the Toys-R-Us organization was very profitable, but for tax purposes, most of the profits ended up in Delaware, a state with no corporate income tax.

The way to close this loophole is to join the 24 other states who have enacted Combined Reporting. Instead of reporting separately, multistate corporations have to combine all profits on one form. It makes sure that businesses who take advantage of Arkansas roads, infrastructure, and economic incentives pay their fair share. Combined reporting in Arkansas would reduce corporate income tax avoidance, raise state revenue, and create a level playing field for small businesses who pay full taxes under current laws.