Originally published on Forbes.com July 14th, 2014
Although it has spread further, I always think of Dunkin Donuts as something of a Massachusetts institution. The first time I encountered one was while hitchhiking between Boston and Worcester. The iconic brand did have its headquarters in Randolph Mass (now Canton), but I was surprised to learn that its ultimate parent was foreign, based in the UK actually (see note). I got this and other information from a recent decision by the Massachusetts Appellate Court – Allied Domecq Spirits & Wine USA (Not a direct link). Some really clever people in the corporate tax department thought that they had a plan that would reduce Massachusetts corporate income tax to “nil”. The Massachusetts Appeals Court is backing up the Department of Revenue and telling them that it’s time to pay the taxes.
My own reading is that the corporate tax people may have been too anxious to brag about their cleverness.
Some Background
Some of the most sophisticated tax planners you will find are not working on federal income taxes, but rather state. If you have more than the most simple multi-state operations, just being in compliance, or at least reasonable compliance, is tremendously complicated. Focusing here just on income taxes, you will find that most states have a formula based on sales, payroll, and property that arrives at a percentage that is used to apportion part of the taxable income to that particular state. Other income is “allocated”. It gets very confusing because from state to state there will be subtle variations in what income is apportioned rather than allocated and how both the numerator and denominator of each of the fractions are computed. Bottom line, the percentages for each state will usually not add up to 100%. Sometimes it is more and sometimes less. Further, when you get to group returns there can be variations from state to state as to which companies are in the group.
That’s where state and local tax experts come in, like my friend Sylvia Dion. A lot of what they do is just get people in compliance, often bringing a stack of returns to a state revenue department to work a deal for some company that wants to minimize penalties. As the stakes get higher, SALT experts play another role. In Confidence Games, which chronicled the tax shelter scandal of the turn of the millennium, the authors explain how corporate tax departments had converted themselves from cost centers to profit centers, by focusing more on minimizing taxes rather than simply being in compliance.
The Plan
A key concept in state corporate taxation is nexus. It is a slippery concept. The amount of contact that creates nexus can be quite slight. I have written about a Delaware company that ended up with New Jersey nexus, because of a telecommuting employee, who could have been anywhere as fare as the company was concerned. Planners, of course, are generally trying to avoid nexus, but not always. The clever people in the tax department at Allied Domecq realized that by pulling a company with persistent losses into their Massachusetts return, they could shelter the income the company was making on all those donuts it was making in Massachusetts. They thought they could reduce Mass corporate income tax to “nil”. I guess they put it that way being a British company and all. Maybe they thought they were getting even for the Boston Tea Party. Massachusetts didn’t want to pay tax on tea, so why should a British company pay tax on selling coffee in Massachusetts.
Tooting Their Own Horn
What’s the point of having a clever plan if management does not recognize how clever you are? That may have been the downfall of this particular plan.
In July and August of 1996, employees of ADSWUSA’s tax department produced several internal communications advocating arrangements that they believed would have favorable tax consequences for ADSWUSA. A July 26, 1996, memo declared,
“The Massachusetts state income tax can be reduced to nil, and thus save approximately $500,000 annually, by creating sufficient in-state activities for ADNAC. This would allow ADNAC to become part of the Massachusetts combined tax return and thereby apportion sufficient losses to eliminate the entire combined state taxable income…. This would be achieved by subleasing office space from Dunkin’ Donuts Incorporated … and transferring and insurance personnel to ADNAC thereby creating $250,000 of in-state payroll…. Furthermore, office furniture and equipment costing at least $10,000 should be owned by ADNAC in Randolph.”
As sometimes happens when a maneuver is purely tax-motivated execution was less than thorough.
In August, 1996, ADNAC began to reimburse Dunkin’ Donuts for the salaries of three insurance employees and two tax employees in Randolph and to pay rent to Dunkin’ Donuts for the office space occupied by the tax employees. However, these employees’ work did not change in August, 1996, and all five employees received W-2s from Dunkin’ Donuts both before and after the purported transfer. They never received W-2s from ADNAC during the tax years at issue.
The Problem
“Massachusetts recognizes the ‘sham transaction doctrine’ that gives the commissioner the authority ‘to disregard, for taxing purposes, transactions that have no economic substance or business purpose other than tax avoidance.”
A review of the record makes clear that the 1996 transfer of the tax and insurance departments to ADNAC “had no practical economic effect other than the creation of a tax benefit and that tax avoidance was its motivating factor and only purpose.” Ibid. The tax department memos from July and August, 1996, demonstrate a tax purpose for the transfers, while the assurance that there would be “no impact to the management results” supports a conclusion that there would be no practical economic effect. In addition, the employees’ work did not change following the transfer, and they continued to be paid by Dunkin’ Donuts, which was then reimbursed by ADNAC. The lease of office space to ADNAC was insufficient to house all the transferred employees, and the rent paid decreased each year until the lease lapsed entirely in 1999.
There were some further complications, but the Court would have none of it. The tax department memos were referred to as smoking guns and the Revenue Department won the case for all years.
In most cases, I root for the taxpayers, but this time I was with the home team. Massachusetts has tremendous loyalty to Dunkin Donuts, so the company should be contributing more than “nil” to the Commonwealth’s infrastructure.
You can follow me on twitter @peterreillycpa.
Afternote
In addition to its intrinsic interest, I could not resist this case because it is about Dunkin Donuts and I have a little story about how much we like Dunkin Donuts in Massachusetts.
One of the most a amazing things about working for a national firm was the amount of time and money wasted on “soft” continuing professional education. One such venture was a mandatory seminar for partners and managing directors called “Unleashing Your Potential” or something like that. If you missed it when the circus came to your region, you would have to travel someplace else to attend it, so I made sure to schlep into the Boston office when the show came to the New England cluster.
In an effort to get some sort of inspiring discussion going, the presenter asked for examples of great companies. Some of the Arthur Andersen refugees in the crowd brought up their departed alma mater, which I thought was rather odd. After a while, though, the presenter brought forth his example of a great company -Starbucks. Apparently, this had flown in the rest of the country, but he found that in New England, there was a resounding chorus of “Starbucks sucks. We like Dunkin Donuts”. We heard that he related the story when he traveled the rest of the country encouraging partners and managing directors to unleash their potential.
Correction: I heard from Dunkin Brands who pointed out to me that their ownership structure and headquarter have changed since the period covered by this case. They indicated that Dunkin Donuts itself had not been accused of owing any Mass taxes. It was its then parent that was trying to shelter its Massachusetts profits. “Dunkin Brands”, headquartered in Canton, Massachusetts, has in fact been publicly owned since 2011. The company had had no association with UK-based Allied Domecq since the company separated from Period Ricard and was purchased by a consortium of private equity firms in 2006.