Wal-Mart suit plows ahead

North Carolina, retailer raise storm of paper in fight over $30 million in taxes

The $30 million tax battle between Wal-Mart and the state, which has produced a 6-foot-high stack of legal documents to date, is in its second year and still going strong.

Wal-Mart has been seeking a $30.2 million tax refund since March 2006, when it sued the state and accused it of improperly assessing its corporate income tax bill.

The state counters that the world's largest retailer, in effect, gamed the system through the aggressive use of tax shelters that sought to obfuscate its "true earnings" in North Carolina.

The state's motion to dismiss the case was denied last year. Now both Wal-Mart and the state are asking Wake County Superior Court Judge Clarence Horton Jr. to decide the case in their favor based on evidence produced through the discovery process, which enables the two parties to gather information from each other.

A hearing on those motions is expected to be scheduled for later this year, said Noelle Talley, a spokeswoman for the state Attorney General's Office.

If neither side prevails, the case could proceed to trial.

Wal-Mart paid $30.2 million in extra taxes, interest and penalties that the state claimed the retailer owed following an audit for the four fiscal years that ended Jan. 31, 2002. Wal-Mart, which has more than 100 stores in the state, is seeking a refund of that money, plus interest.

A companion lawsuit was filed by Sam's Club, the warehouse chain owned by Wal-Mart, seeking a $3.5 million refund from the state. Those two lawsuits have been consolidated.

In court documents, the state says that, according to one estimate, "North Carolina lost $301 million in corporate tax revenue in 2001 alone due to tax sheltering."

The attorney representing Wal-Mart, Jack Cummings of Alston & Bird in Raleigh, declined to comment on the litigation.

At the crux of the Wal-Mart case is an intricate corporate structure involving a Real Estate Investment Trust and a REIT holding company. During the period at issue, Wal-Mart was the sole owner of a REIT holding company, Wal-Mart Property Co., which in turn owned the majority of the REIT, Wal-Mart Real Estate Business Trust.

In essence, Wal-Mart used this structure to pay rent to itself and to pay dividends to the different entities in a way that lowered its state taxes.

In an interview last year, a Wal-Mart spokeswoman said the structure was created "as part of a larger companywide restructuring to more effectively and efficiently manage our business, including our ever-growing real estate portfolio."

But the state contends it's the product of "tax avoidance strategies" designed to exploit the state's tax laws. As a result, the state Department of Revenue combined the returns of the various Wal-Mart entities into a single return and then calculated an overall tax bill.

The state contends that the secretary of revenue is authorized to require a corporation to file a consolidated return upon determining that its tax return "does not disclose [its] true earnings" attributable to the state.

At least a half-dozen other states, according to The Wall Street Journal, have gone after other companies that have used similar structures to cut their tax bills.

Although the state revenue department attacked Wal-Mart's structure by consolidating returns, the General Assembly provided the department with an alternative weapon by altering the tax treatment of certain types of REIT dividends. That change took effect Jan. 1.

Wal-Mart contends the way the state calculated its tax bill violates the due process and commerce clauses of the U.S. Constitution and portions of the state constitution. By combining returns, the retailer argues, the state determined Wal-Mart's taxable income "in an arbitrary manner, without the guidance of any constitutionally acceptable standard."