BEYOND THE NUMBERS
Minnesota Bill Marks Major Step Forward in Preventing Multinational Corporations from Shifting Profits Abroad
The Minnesota House and Senate passed two tax bills containing a critical provision aimed at stopping multinational corporations (MNCs) from shifting profits earned in the state onto the books of subsidiaries in foreign tax havens and low-tax countries. If the “worldwide combined reporting” (WWCR) provision were enacted, Minnesota would treat corporations consisting of a parent company and its U.S. and foreign subsidiaries as a single entity for tax purposes. With negotiations under way to reconcile the differences between the two bills, the conferees should ensure that the WWCR mandate stays in the final bill, and Governor Tim Walz should sign it.
Minnesota is one of the 28 states that already require combined reporting for U.S. parent corporations and their subsidiaries within the U.S., known as “water’s edge” reporting. Minnesota lawmakers knew that corporations doing business in the state could easily use internal accounting schemes to shift profits earned in the state onto the books of subsidiaries in low-tax states, and in 1982 the state mandated water’s edge combined reporting to prevent it.
The most well-known interstate tax avoidance such scheme was the “trademark holding company.” Its most famous exploiter was Toys R Us, which transferred its Geoffrey Giraffe and other trademarks to a subsidiary in Delaware. It then siphoned profits out of all its stores by having the subsidiary charge the stores tax-deductible royalties to display the trademarks. Since Delaware didn’t tax the royalty income of the subsidiary, the scheme reduced the overall state income tax liability of the Toys R Us corporate group. In requiring water’s edge combined reporting, however, Minnesota taxed a share of the combined profit of the local Toys R Us stores and the Delaware subsidiary, nullifying the tax reduction from the profit shift.
State policymakers also attempted to stop corporations from shifting profits across national borders. By the early 1980s, 12 states (not including Minnesota) were mandating WWCR, combining the profits of U.S. parent companies with their foreign subsidiaries and the profits of foreign parent companies with their U.S. subsidiaries.
However, some foreign governments (advocating on behalf of their resident MNCs) pushed the Reagan Administration to pressure those states to repeal their mandatory WWCR. In 1984 the states reluctantly conceded ― contingent on the federal government taking meaningful and effective action to enforce federal laws barring abusive international profit shifting, which also erodes the federal tax base. (WWCR became optional in some of those states; corporations use it only when it results in a more favorable tax liability.)
Fast-forward almost 40 years, and the federal government’s commitment to curbing international profit shifting remains substantially unfulfilled. Multiple studies show that MNCs continue to use strategies to shift massive amounts of profits beyond the reach of the federal and state treasuries, such as by manipulating prices on sales of goods and services between parents and subsidiaries. This profit shifting has continued despite the 2017 federal tax bill’s inclusion of several new approaches for limiting it. A 2022 Congressional Research Service study found, for example, that the profits supposedly earned by U.S.-based MNCs in the tax haven nations of Barbados, Bermuda, the Cayman Islands, Jersey, and Mauritius in 2018 were many times larger than the entire economic output of those countries.
WWCR opponents have responded with false claims about how the WWCR mandate would affect Minnesota. The state’s lawmakers should push back on these claims, and assert that:
- WWCR is not unlawful, and threats to sue Minnesota aren’t credible. Two separate U.S. Supreme Court decisions have upheld the fairness and constitutionality of WWCR. There have been similar unexecuted threats of lawsuits against any state that attempted to nullify international income shifting by piggybacking on the new 2017 federal provisions.
- MNCs will not reduce current or future corporate investments in the state. Minnesota corporate tax liability no longer depends on the level of investment in the state. This means that corporations in the state would have to take the rather implausible step of refusing to sell to Minnesota customers to retaliate.
- WWCR will not increase the volatility of Minnesota corporate tax collections. MNCs already can use the same schemes that shift profits out of the U.S. to shift foreign losses into it.
- WWCR does not impose an unreasonable compliance burden on corporations. Alaska has applied WWCR for decades to oil companies. While no other states mandate WWCR, some other corporations are quite willing to incur those “burdens” when WWCR reduces their taxes in the ten states that allow companies to elect its use.
The Wall Street Journal asserted that an Institute on Taxation and Economic Policy (ITEP) study, which Minnesota relied on to estimate the revenue gain from WWCR, exaggerates the gain. This assertion is questionable given that an independent California estimate of the potential revenue gain from mandating WWCR is larger than the California estimate in the ITEP study.
The Wall Street Journal’s claim that we could see a replay of 1980s European government opposition to mandatory WWCR is also dubious. The Organisation for Economic Co-operation and Development has recognized the severity of MNC “base erosion and profit shifting” and introduced an approach to reduce it that treats MNCs as a single enterprise analogous to what WWCR does.
WWCR bills have been introduced in Hawai’i, Illinois, Kentucky, New Hampshire, and Oregon in recent years. Minnesota’s enactment of WWCR may well encourage them and other states to follow suit. This would benefit small business competitors that don’t have subsidiaries in foreign tax havens and would force MNCs to pay their fair share of income taxes so that our schools, public health care systems, and communities have the resources they need to thrive.