What’s a “related entity”?
What’s a “strategic partner”?
State officials didn’t know exactly when drafting legislation that would grant $242 million in “economic incentives” for Dell, Inc., to build a computer plant in North Carolina.
In emails recently released by the N.C. Commerce Department, crafters of the Dell legislation expressed concern over the definition of some critical language that would allow Dell to set up other entities at the plant site. The emails said that fuzzy language included in drafts of the bill might allow the company to bypass its negotiated guarantees with the state—including the 1,200 full-time jobs supposed to be created by the legislation and $100 million to be invested in the plant by Dell.
Commerce Department officials and bill drafters exchanged a flurry of emails concerning the details of the bill only one day before the Easley administration brought the measure to a special session of the General Assembly. Assembly leaders, including the bill’s sponsor, Sen. David Hoyle of Gastonia, hurried the bill through the legislative process until it was approved and sent to Gov. Mike Easley. The governor signed the bill on the same day.
“North Carolina has struggled for years with companies using related entities as a tax avoidance mechanism,” said an email sent by Martha Harris, of the legislature’s bill drafting division, to Don Hobart, lawyer for the Commerce Department. “Companies create related Delaware holding companies and use accounting tricks to eliminate their NC taxable income. Companies create complex chains of related companies to shift property into LLCs and avoid franchise tax.
“If we make this bill’s language wide open, we are just leaving fertile ground for more creative ideas — not necessarily by Dell, but this law does not apply to just Dell. Staff can’t predict and enumerate specific methods for exploiting the proposed broad language. That is the nature of loopholes. They are overlooked and then exploited later contrary to the legislature’s intent.
“Because NC is a separate entity filing state, the [Department of Revenue] cannot view the entire web of inter-related entities to determine the real economic effect of their actions. Also, you are giving one entity a credit for activity undertaken by another, which is contrary to existing tax provisions in our law.
“Shifting income and expenses between and among various related entities is the essence of tax avoidance. Has the Department of Revenue been fully briefed on what is intended here with related entities? Do they have any concerns of questions?
Then Harris expressed doubt that the package for Dell could deliver the economic benefits highly touted by Gov. Mike Easley and other state officials.
“I could not recommend that the General Assembly give a broad carte blanche like this when we are lacking facts and details as to what is going to be done. If Dell can’t or won’t give us an idea of how many and what type of related entities will be making the investment and/or creating jobs, how can we know what they will do in exchange for the millions of dollars we are giving them?
“To be eligible they would not be required to invest a certain amount and create a certain number of jobs, but just have some entity or groups of entities invest and create jobs or enter into some accounting tricks to make it look like they did.”
In his response to Canaan Huie of the Bill Drafting department, Hobart acknowledged he, too, pondered the inclusion of related entities:
“Anticipating further discussions over including related entities in the job creation count for the computer credit…can you describe a fact pattern that gives you concern about including related members in the job count for eligibility?
“If the issue is how many new jobs did the taxpayer cause to be created at the facility, and if we apply the safeguards to the related members just like we would to the taxpayer, why would it matter whether the taxpayer creates the jobs itself or through a related member?
“We wanted to limit the ability of strategic partners to have their jobs counted because the company would have no true control over the strategic partners and we wanted to limit the number of their positions that would count to just those that directly contribute to manufacturing. The related number, however, is just another arm of the company operating on the campus.
“I am expecting resistance on limiting this and trying to make sure we have an appropriate response.
“Also, regarding the concerning about timing of the $100M investment, we understand your concerns and will push back on this. Do not make an adjustment to this language at this time.”
In one email Huie raised other questions for Hobart to consider.
“Here’s the opportunity I see for tax avoidance using the related entities. I don’t know that narrowing the scope will help much, but here’s the scenario.
“Dell Products comes to NC with significant income. They use the related entity not only to construct the facility, but to hold the property as well. Then, they use the related entity to meet many of the jobs requirements. They manipulate payments to the related entity so that it has very little income. When it comes time to apportion income, Dell Products has very few of its payroll or property in the State. Since Texas and Tennessee don’t have income taxes, Dell may be the legal entity that holds the property and has the payroll in those states. This could vastly decrease those apportionment factors so that very little of the income is apportioned to this State and a majority of it is apportioned to the states without income tax.”
Hobart answered Huie by saying that the Department of Revenue had reviewed the details of the proposed tax credit for Dell and found it to be OK.
The final definition of a “related entity” was offered in an email from Jim Fitzgerald of Dell to Hobart: “An entity that the taxpayer possesses directly or indirectly at least 80% of the control and value” of both entities.
That’s how the definition stood in the bill approved by the legislature.
The bill defined a “strategic partner” as “a business that is engaged in activities at the facility that directly contribute to the manufacture and distribution of computers and computer peripherals and with whom the taxpayer has contracted to provide those activities at the facility in direct support of its manufacturing and distribution activities.”
The final bill also included language for “relationship with related entities and strategic partners:
“A taxpayer must obtain the written consent of related entities and strategic partners to include jobs created by those entities in the taxpayer’s increased employment level. If a taxpayer fails to obtain this written consent, the taxpayer may not include jobs created by the applicable business in its increased employment level. This consent, once granted, is irrevocable. A job may not be included in the increased employment level of more than one entity. The taxpayer is responsible for providing all information needed to verify eligibility for the credit, including information relating to the related entities or strategic partners of the taxpayer.”
Many legislators had complained before the bill was introduced that the administration did not give them enough time to study the bill before it was introduced.
Carolina Journal and the North Carolina Press Association filed a lawsuit against the Commerce Department on Jan. 19 to force disclosure of all public records on the Dell negotiations.
Richard Wagner is the editor of Carolina Journal.