Franchot to change policy on REIT rents

Md. losing millions through `captive' setups, he says

March 06, 2007|By Tricia Bishop | Tricia Bishop,SUN REPORTER

State Comptroller Peter Franchot will join other states in changing a policy that's costing Maryland "tens of millions" of dollars in taxes by allowing businesses to use investment trusts to deduct rent expenses.

"It's an abuse that allows big companies to cheat on state taxes, and it's wrong, so we're going to begin to audit these companies," Franchot said. "These practices are going to no longer be permitted, and we're going to seek to level the playing field for all Maryland businesses."

Franchot declined to name the companies he believes are involved. He is scheduled to formally announce the plan this morning.

In 2003, Wal-Mart, which has more than 50 stores in the state, transferred ownership of its Ellicott City store to a Delaware holding company. That set up a "captive rent" relationship, which allows the discount giant to pay rent to itself, then deduct those payments as a business expense from its taxable income in Maryland.

It was a largely ignored legal shelter until a Wall Street Journal article last month highlighted the practice, and its use in 24 other states, leading Franchot's office to study the matter.

According to the Journal article, Wal-Mart has avoided paying millions in taxes to multiple states by having its locations pay rent to a real-estate investment trust, or REIT, that's 99 percent owned by a Wal-Mart subsidiary.

The other tax benefit to such an arrangement is that REITs don't pay income taxes if they distribute most of their earnings to shareholders.

Wal-Mart spokesman John Simley has said that putting property in a separate company helps store managers focus on store matters rather than real estate issues. The practice is also employed in states that don't offer similar tax benefits, he has said.

"It is our policy to comply with all laws in every state in which we do business. This is a lawful structure in Maryland," Simley said yesterday. "We are in compliance with state tax laws and will continue to be in the future."

The company collected $120.4 million in sales taxes for Maryland from February 2005 through January 2006, and it paid $16.8 million to the state in taxes, according to Wal-Mart figures.

Massachusetts revenue officials are in court over a similar situation with Bank of America and both Louisiana and Kentucky have had captive-rent disputes with auto-parts chain store AutoZone. In January, New York Gov. Eliot Spitzer said he plans to eliminate the possibility for companies to deduct such REIT expenses as part of his proposed budget, estimating annual lost revenue of about $83 million.

In 1960, Congress passed the Real Estate Investment Trust Act, which allowed individuals to pool their money and invest in significant amounts of real estate without acquiring the property. The idea was to open the real estate investing market, traditionally accessible only to the wealthy, to average Americans.

But it also opened the door for situations like Wal-Mart's, said Joseph R. Crosby, legislative director for the Council On State Taxation. Crosby said he was concerned that many government officials are using the word "loophole" to describe a practice that is legal.

"Generally speaking, I've seen the word `loophole' used in cases where companies are simply doing what the legislature indicated they should do," Crosby said.

A bill to outlaw the practice was introduced in the Maryland legislature during the 2005 session, but didn't pass.

Franchot was careful to point out his actions had nothing to do with traditional REITs.

"A majority of all REITs in the country are based in Maryland, and we value these corporate entities," Franchot said. "They provide a very strong public policy purpose, which is to allow individuals and companies to invest in real estate. ... What we are concerned about are captive or subsidiary REITs that are set up by companies to avoid paying state taxes."

Cracking down on businesses that use Delaware holding companies to avoid paying Maryland taxes on intangible property such as slogans was a pet project of former Comptroller William Donald Schaefer, who pushed for a law to stop such practices in 2004. Franchot said that law also gives him the authority to squash the captive-rent practice.

"These types of tax avoidance schemes ... will no longer be accepted by our auditors as legal." Franchot said. "The system falls apart if some people, because they have brash leadership and clever accountants, decide that they're not going to pay what they owe."

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