Senate would scrap tax penalty

The revenue department calls it a vital tool against tax dodgers. Foes say it's unfair.

Staff writerJune 17, 2010 

— The state Senate and the business lobby want to take away a big stick that the state's tax collector says it needs to punish big businesses that dodge their taxes.

The issue is up for debate in budget negotiations under way between the state House and Senate. The Senate's version includes a provision that would prevent the N.C. Department of Revenue from assessing a penalty on businesses it thinks are hiding income. The provision is not included in the House's version.

N.C. Department of Revenue Secretary Ken Lay, who is under pressure to maximize the state's collections in the aftermath of a deep recession, says he needs the ability to assess penalties to force companies to be honest. Without the penalties, the revenue department thinks it would miss $100 million in taxes it would otherwise collect. The state faces an $800 million revenue shortfall.

Lay said his agency pursues cases in which businesses are deliberately trying to hide income through complex schemes and out-of-state partnerships.

The Senate's budget "gives the green light for companies to keep doing that," Lay said in an interview. "I'm not sure I follow the logic on why this is a good thing."

Supporters of the idea say the revenue department is overstepping its authority and unfairly punishing business. The penalties punish a well-intentioned company that had no way of knowing the department would disagree with its tax return years later, they say.

"We don't do that to any other taxpayer," said Sen. Dan Clodfelter, a Charlotte Democrat pushing for the change. "That would be the equivalent of saying to somebody, 'I'm going to really fine you a stiff fine for speeding, but I'm not going to post the speed limits.'"

Clodfelter said the budget provision is meant to clarify what he says is already the law. The N.C. Chamber and a host of other business groups support the measure.

Pressure and anger

The debate concerns cases in which state officials think businesses that operate in multiple states aren't paying the true amount of tax they owe North Carolina. In those cases, the state can require a so-called consolidated tax return, which would include all of the company's assets and revenue from all states. The state could then use that information to determine whether an out-of-state entity is simply a tax dodge. If the department determines through examining consolidated returns that the company underpaid by 25 percent or more, it has been assessing penalties up to 25 percent of the underpaid tax.

Businesses can't file combined returns unless the state orders them to. Supporters of the change say they are essentially being punished for not anticipating the department's eventual determination.

The state has not been distinguishing between legitimate business tax planning and deliberate dodges, said Chuck Neely, a Raleigh-based lobbyist for the Washington-based Council on State Taxation. He represents multi-state corporations in such disputes with the N.C. Department of Revenue.

"The career professionals down there are good people, but I think the money pressures and maybe the anger ... at what they perceive to be abuses have driven this," Neely said.

Revenue officials describe the penalties as a stick that helps keep companies in line. Without them, officials say, companies have every incentive to take a chance on hiding income, a scenario that revenue officials describe as the "audit lottery." The penalties, which the department can waive, can lead to a quick resolution of tax disputes or help avoid them entirely, Lay said.

In December, the department announced that it had come up with $427 million in a program to settle tax disputes with corporations and businesses. The penalties are key to the department's plans to collect another $100 million in the next year, Lay said.

Even without the penalties, North Carolina has the legal authority to collect unpaid taxes and interest, Neely said. And a company fighting the government has to spend money on lawyers and face the possibility of losing in court.

"Tax cases settle routinely all across the country without penalties where the taxpayer and the Department of Revenue say, 'Maybe you got a point. Let's see if we can come to a resolution,'" Neely said.

Taxpayer information is confidential, so it's difficult to know how common the disputes are. Neely said it's one of the biggest issues facing the department.

Render unto Caesar

State Sen. Phil Berger, an Eden Republican and the Senate's minority leader, said he supports the change, in part because the state can't afford to be hostile to business. Republicans routinely complain that they think the state's tax environment is hostile to businesses considering locating here. But the Democrats control state government. They say the state is consistently ranked as a good place to do business.

The issue is being discussed by a committee of House members and senators who are trying to hammer out a budget compromise. State Rep. Pryor Gibson, a Wadesboro Democrat, said he expects some form of the provision to make it to the budget. He said all taxpayers should only pay what they owe.

"We encourage every taxpayer to avoid taxes if they can," Gibson said. "No taxpayer should evade taxes."

ben.niolet@newsobserver.com or 919-829-4521

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