Extreme tax games

Eventually, when Governor Deval Patrick is ready to climb out of the back seat of his new Cadillac and the business community is ready to climb down off its high horse, the two of them can begin having a rational conversation about what is a tax loophole and what is a tax increase.

Wal-Mart is a good place to begin.

The new governor and the business community are off to a rocky start. Patrick, even before he leased the Caddy for himself and hired the caddie for his wife, was in urgent need of new revenue to balance the budget and keep his campaign promise to do something about rising property taxes. In time we'll get to the budget cutting, but for now the conversation is all about raising revenue: plugging corporate "tax loopholes," reneging on the Legislature's promise to lower commercial property tax burdens, and adding a local-option meals tax.

Why us, business has every right to ask? The best way to grow state revenue is to grow the economy and add jobs. But that does not mean that we have to turn a blind eye to those who may be gaming the system. Which brings me back to Wal-Mart and the issue of corporate tax loopholes.

This month the Wall Street Journal reported how Wal-Mart, the world's largest retailer, pays billions of dollars of rent for its stores -- to itself. And then manages to deduct the rent from its taxes in many states. The tax dodge saves Wal-Mart hundreds of million in state taxes annually, the Journal estimated.

Here's how the tax loophole works: One Wal-Mart subsidiary pays the rent to a real estate investment trust, or REIT, which gets a tax break if it pays its profits out in dividends. The so-called captive REIT is 99 percent owned by another Wal-Mart subsidiary, which receives the REIT's dividends tax free. And Wal-Mart gets to deduct the rent from state taxes as a business expense, even though the money never leaves Wal-Mart.

My favorite touch: To meet the requirement that REITs have at least 100 shareholders, Wal-Mart distributed 1 percent of the nonvoting shares to more than 100 top executives. Think of them as the captive REIT's captive shareholders.

In all, the Journal reported, Wal-Mart uses the REIT strategy in about 25 states. That includes Massachusetts, where Wal-Mart has 44 stores and three Sam's Club stores, which also uses the same tax-avoidance structure.

Wal-Mart spokesman John Simley calls captive REITs "a lawful structure in Massachusetts," and adds: "We use it even in states where the tax benefit doesn't exist." He maintained that it keeps the retailing operation focused on selling and not real estate.

Of course, Wal-Mart is not alone in trying to minimize its taxes. Several years ago the Massachusetts Department of Revenue settled cases with 69 banks using the REIT structure. The state sued and won $25 million in a case against BankBoston, and is seeking $46 million in a case involving Fleet Funding. Patrick is considering a combined reporting system that would force companies to pay a portion of their US profits in state taxes, thus eliminating the benefit of many tax loopholes.

There is nothing antibusiness about trying to plug such tax loopholes. In fact, it is business-friendly North Carolina that is leading the charge against Wal-Mart's aggressive use of the REIT loophole. Massachusetts should be doing no less.

Patrick and the Legislature should be careful not to jeopardize the long-term imperative to grow the economy by their need to plug a short-term budget gap. But then the business community needs to be careful not to immediately rush to defend tax gimmicks that can't be defended when exposed to the light of day.

Steve Bailey is a Globe columnist. He can be reached at bailey@globe.com or at 617-929-2902.