Before the Conference Committee On HB 405
Interested Party Testimony

Present by: Daniel Navin; director of taxation & public finance for the Ohio Chamber of Commerce
Wednesday – November 28, 2001

Mr. Chairman and Members of the Committee,

My name is Daniel Navin and I am the director of taxation & public finance for the Ohio Chamber of Commerce. With me today are five members of our Taxation Committee who represent Chamber-member companies that will be significantly impacted by the three tax items to which we will direct our comments. I’d like to outline some of the Chamber’s general concerns about the three tax items before turning to my members for their more specific comments.

First, it is terribly unfortunate that this package is being sold as one that involves the so-called “closing of business tax loopholes.” By that line of logic, any transaction between related entities, any valid financial instrument in which people accumulate capital or save/preserve money for college or their heirs that is not taxed, or any tax provision that allows companies or individuals to pay less tax than the maximum allowable according to the tax base and applicable rates is a “loophole.” We were disappointed again yesterday that the administration continues to persist in using that wholly inaccurate, pejorative term with all its negative connotations.

The fact is that no matter how one tries to avoid it, these are “TAX INCREASES” that jeopardize Ohio jobs and local communities across the state. Despite the commentary from various sources that now suggest these are “minor” tax increases, they are being proposed at a time when it is confirmed we have been in a recession for the last eight months, with no clear end in sight. This is not the time to be putting additional tax burdens on Ohio businesses.

Second, Ohio businesses establish budgets and expenditure targets every year based on their estimates of sales or revenues, not unlike the State or local governments or any other governmental agency. Businesses also set spending priorities that often include plans for expansion into other markets, again not unlike governments who may initially plan to increase spending in certain categories or programs. Unfortunately, in financially strained times like these, such best-laid plans must be adjusted in light of the economic realities. As a competitive imperative, a number of Ohio businesses have gone through the painful process of laying off employees or closing plants or other facilities. In other words, Ohio businesses are dealing with the very same tough economic conditions that the State is facing. In today’s unstable economic environment, an approach to balancing the state’s budget that significantly depends on imposing new taxes on Ohio businesses during a recession is, in our view, short-sighted, likely to be counter-productive and does little to help maintain much less grow our economy.

In terms of the policy implications of these proposals, I have received almost forty responses from members of our Taxation Committee to the various proposals that have at one time or another been contained in HB 405. The following comments are a composite summary of our members’ perspectives.

1. Disallowance of Resale and Transportation For Hire Sales Tax Exemptions For Related Entity Transactions

The supposed justification for this proposal seems to be based on the premise that a transaction between affiliated companies is motivated by so-called tax avoidance and is therefore an “abuse,” not entitled to exemption. In the normal course of commerce, including commerce between related companies, goods are not ordinarily sold or leased for an amount less than what was originally paid for them. The only reason for “reselling” goods for substantially less than what had to be paid to an outside, third-party supplier (or for less than it cost to manufacture the goods) would be to reduce sales/use tax liability. If the alleged justification for this idea is to deny the exemption where the item was sold or leased to the affiliate for less than what it cost, the Department of Taxation could be given what is called IRC Section 482/transfer pricing authority to prevent such “abuse.”

Further, in the case of the resale exemption disallowance, this proposal would have the effect of allowing the payment of sales tax over the lease term where the item is purchased by a taxpayer company from a third party, but not allow the same treatment if purchased for the same price and on the same terms from an affiliated company. There are totally legitimate, business related reasons why a company would purchase an item through an affiliate. For example, an internal leasing subsidiary allows a parent company to better manage its assets. To establish a tax policy that summarily precludes arms-length, inter-company transactions from qualifying for these exemptions does not make Ohio’s sales tax system either more fair or more equitable.

2. Expanding PIC Treatment to Interest and Intangibles Payments Made to Out-of-State Related Entities

We can and have lived with the policy under current Ohio law that prevents companies from deducting payments related to the use of company trademarks, patents, royalties and other intangible assets to a Delaware PIC that is arguably set up primarily if not solely for tax reduction purposes. This was a 1991 change that has shut down the practice of making such payments to what were perceived as “sham” corporations that had no economic substance. We don’t have a problem with that.

However, it is quite another thing to disallow a deduction for payments from the Ohio franchise taxpayer to out-of-state subsidiary or parent companies to pull in transactions between affiliated companies that have substantial, legitimate business (i.e., non-tax sheltering) purposes. For example, many large corporations centralize their treasury functions to take advantage of favorable investment and borrowing rates, such that an interest payment from one affiliate to another affiliate is an ordinary, necessary business expense regulated by the federal Securities & Exchange Commission.

Corporations are free to organize any number of separate legal entities for any number of business and tax reasons. Ohio up to now has generally recognized the separate legal existence of these affiliated companies and not taken a “unitary’ or “forced combination” approach. To start down that road, this bill is sending a very bad signal, both to existing companies with Ohio operations and to the business community at large.

3. Net Operating Losses (NOL) Deductibility Suspension

The provision to suspend the application of net operating losses is a proposal to kick companies when they are down. It essentially deprives companies an opportunity to benefit from expenditures that profitable companies already recognized. For many start-up companies, some of whom are just beginning to show a profit and other established businesses experiencing tough times, it’s the wrong idea at the wrong time.

Further, this idea changes the rules in midstream. Particularly for cash-strapped companies, of which there are probably now a few, the additional cash required to pay more Ohio tax without the NOL carry-forward will be detrimental.

Mr. Chairman, that completes my testimony, and our other witnesses will now offer their comments.