Tax Law Blog | IRS Tax Attorneys

US retail giant Wal-Mart has lost a legal battle to reclaim USD33.5m in tax it paid to the state of North Carolina in a case that may have implications for the way in which US businesses organize their corporate structures.

Wal-Mart was appealing the USD33.5m bill for back taxes, penalties and interest imposed by North Carolina, which had argued that rental payments made by the company to a Wal-Mart subsidiary were improper. However, the state Court of Appeals ruled on May 19 that the state Secretary of Revenue “acted within his lawful authority” when he assessed additional taxes against the company.

“The language of the statute is broad, allowing the secretary to require combined reporting if he finds as a fact that a report by a corporation does not disclose the true earnings of the corporation on its business carried on in this state,” wrote Judge Donna Stroud in her opinion, which was supported by the two other judges on the panel.

North Carolina assessed the additional taxes on Wal-Mart after taking issue with the way in which the company had organized its business to claim a large state tax deduction.

Under this structure, Wal-Mart transferred ownership of all of its stores to a Wal-Mart subsidiary. In most states, this enables Wal-Mart to deduct the “rent” it pays the subsidiary (i.e., the rent it pays itself) from the income that is subject to state corporate taxes. The subsidiary receiving the rent isn’t taxed because it qualifies as a tax-exempt Real Estate Investment Trust under federal and state law – provided it distributes at least 90% of its income in dividends.

According to a 2007 Wall Street Journal report, this structure saved the retailer USD230m in taxes in many states over a four-year period.

The North Carolina Appeals Court decision could strengthen the cases of other states which are seeking to outlaw such practices, and could affect other companies with similar arrangements to those of Wal-Mart.

The company, however, could appeal the latest decision to the state’s Supreme Court.

While Wal-Mart was still reviewing its legal options at the time of writing, a company spokesperson said that taxpayers should be able to rely on “clearly defined laws that are reasonably and fairly enforced.”

Source