Franchot Closes Corporate Tax Loophole

ANNAPOLIS, MD - Emphasizing his commitment to ensure that every business pays their fair share, Maryland Comptroller Peter Franchot today announced that Maryland will no longer allow payments to "captive" Real Estate Investment Trusts (REITS) to be deducted from state corporate income tax returns. Franchot said the state will begin auditing companies using this tax loophole and seek to collect the taxes it is owed. It is estimated that Maryland could bring in millions of dollars annually in additional revenue due to this change in policy. The Comptroller was joined by small business owners, labor leaders and public advocacy groups.

"The sole purpose of a captive REIT is tax avoidance," Franchot said. "And as Maryland Comptroller, I will no longer allow these companies to avoid paying their fair share.

A REIT is defined as a corporation or trust whose activity is limited to real estate operations. REITS are required by law to pay all their income to shareholders who then pay the appropriate tax; therefore, a REIT is normally tax exempt at the federal and state level. Over the years, large, multi-state companies have formed "captive" REITS; in order to lower the taxes they pay in the states they do business. It works in the following manner:

A company with stores in Maryland creates a REIT and has all of its stores pay "rent" to the REIT. The parent company then creates another subsidiary to be the "shareholders" of the REIT and receives all the dividends from the rent payments. In essence, the company is paying rent to itself, getting the money through a tax-free REIT and then deducting the rent payments from its Maryland corporate income tax. According to the Wall Street Journal, the state of North Carolina sent a bill to one company, Wal-Mart, for $30 million to cover back taxes. Several other companies and financial institutions have been cited in other states for this practice. In New York, it is estimated that the state is losing out on $83 million annually thanks to this loophole.

"We want to thank Comptroller Franchot for taking a proactive leadership position on this important issue," said Donna Edwards, Secretary-Treasurer of the MD/DC AFL-CIO. "This is money that should be going to or public schools and to expanded health care coverage for the people of Maryland. Companies that do business here and reap the benefits should be partners in building up our communities and need to do the right thing."

The cost savings and added profit give companies an unfair advantage over local competition and make it even harder to compete with the giant stores. The vast majority of Maryland businesses are paying their fair share and Comptroller Franchot is determined to do what it takes to level the playing field. The add-back provisions of the 2004 Delaware Holding Company statute gives the state the right to add back intangible expenses and costs paid to related entities for a tax avoidance purpose. The law also gives the Comptroller the authority to reallocate deductions, expenses and transactions among related entities to clearly reflect income. Captive REITS fall under this law as they are transactions among related entities and have no purpose other than state tax avoidance.

Maryland has long been a leading center for REITS. In 2006, 326 REITS paid the state's $300 Annual Report fee for total General Fund Revenue of $97,800. This makes Maryland home to well over 50 percent of the nation's REITS according to the National Association of Real Estate Investment Trusts. The genesis of this can be traced back to 1963 when Maryland became the first state to pass a REIT statute called the Maryland REIT Law. In addition several factors have contributed to keeping Maryland a REIT magnet, including:

• Maryland has no franchise tax;
• Maryland has a statutory standard of conduct requiring REIT directors to perform duties in good faith;
• Maryland does not require any REIT trustees to be a resident of the state;
• Maryland allows the board of directors to have exclusive powers to adopt amend or repeal REIT bylaws.

It is important to note that the typical investment REIT, corporate REIT and trust REIT will not be effected by today's action. The accounting practices targeted by the Comptroller are used solely by the captive REITS and are solely for the purpose of tax avoidance.