Delaware, the Corporate Clown Car
Those without the leisure to read the Sunday New York Times over their morning coffee(s) might have missed the story published June 30th on how two-thirds of the companies in the Marcellus Shale Coalition—400 corporate subsidiaries—are sharing the same little building at 1209 N. Orange Street in Wilmington, Delaware. And they’re not alone–285,000 separate businesses share the same legal address.
Why have so many corporate giants, along with subsidiaries of Apple, Comcast, and Wal-Mart, squeezed their names into the same nondescript building?
To take advantage of Delaware’s generous policy of not taxing corporate income from things like leases and royalties. According to PennLive, the Pennsylvania Department of Revenue estimates that multistate businesses saved $493 million from the loophole in 2009. Put differently, Pennsylvania lost close to $500 million in revenue.
This loophole, the Passive Investment Company (“PIC”) subsidiary, is often referred to as the Delaware Loophole, or the Geoffrey Giraffe or Geoffrey Loophole, after Toys “R” Us’s not-so-innocent use of its mascot.
- Set up a subsidiary in Delaware. As shown by the New York Times article, this subsidiary doesn’t have to really exist. An address will do.
- Assign the rights to corporate trademarks, copyrights, etc. (Geoffrey Giraffe, or in this case, drilling leases) to the subsidiary.
- Pay huge royalty fees to the subsidiary for the use of the trademark, or send all of the lease profits to their putative owner, the subsidiary.
- Deduct those fees or omit those profits from your corporate taxes in Pennsylvania as expenses, since you had to give all that money to the subsidiary. Meanwhile, in Delaware, your subsidiary doesn’t pay any taxes on the income.
- Enjoy your money, since you own the subsidiary.
Oh, but if you’re a small business without operations outside of Pennsylvania and the money to hire fancy accountants and a mailbox and the occasional conference room in Delaware? You’re S.O.L. Thanks for keeping Pennsylvania (somewhat) afloat, though.
Corporate law firms know the value of expertise in building personalized Geoffrey Giraffes. For example, on its Marcellus Shale page, Saul Ewing LLP, a Delaware law firm, advertises “tax lawyers who provide clients with advice and representation with regard to federal, state and local tax issues, minimizing tax impact both in the current financial situation and for future tax savings.”
For once, Delaware is a more popular destination than the Cayman Islands. When you make a shell company in the Cayman Islands, you have to say who owns it and pay taxes to bring that money back to the U.S. In Delaware, it’s yours forever, assuming your state doesn’t have combined reporting laws.
In March, 2012, the Pennsylvania House of Representatives created a bipartisan bill, HB 2150, aimed at closing corporate tax loopholes. However, as the Pennsylvania Budget and Policy Center noted in their detailed opposition to the bill, the bill would have cost Pennsylvania more money by soothing corporations with major tax cuts and leaving the loopholes accessible to any clever accountant. Another alternative is combined reporting, which prevents corporations from hiding their income in subsidiaries. According to the PBPC, of the 45 states with corporate taxes, 35 have worked to close tax loopholes through combined reporting or expense addback laws. Pennsylvania and Delaware are two of the ten that haven’t, and the only two in the entire northeastern quadrant of the United States.
While Pennsylvania’s government dithers about how to best accomodate Marcellus shale drilling, the companies have their priorities straight. The Pennsylvania State Democratic Caucus website notes that during the same time period as they busily created subsidiary after subsidiary, some of the same companies were ignoring DEP production report deadlines. More precisely, in 2010, 41 of 74 companies missed the deadline. Maybe with a few more loopholes, they can afford to hire people to take care of that environmental stuff.