Orlando-based Darden Restaurants has cut its corporate taxes in some states by renting restaurants from itself, using a strategy that has led to challenges and millions of dollars in back taxes for some other big companies.
The owner of chains including Olive Garden, Red Lobster and LongHorn Steakhouse has put some of its almost 1,900 restaurants into two tax-exempt real-estate investment trusts. Darden leases the restaurants and takes tax deductions on those expenses, while the trusts pay dividends back to the company.
Darden, Orlando's only Fortune 500 corporation and the world's largest full-service restaurant company, said in an email that its trusts are designed primarily to help better manage its real-estate portfolio. The company says its tax savings are "nominal."
But a half-dozen state revenue officials, financial analysts and tax experts interviewed by the Orlando Sentinel said that the primary motivation for shifting property into real-estate trusts is usually tax savings.
"Why do you do that other than for the tax advantages?" said Joe Garrett, a tax-policy administrator with the Alabama Department of Revenue. "That doesn't help you manage your real estate any better."
State auditors are prohibited from discussing specific companies. But a REIT structure such as the one Darden describes in its annual financial reports "would raise a red flag for us," said Linda Tanton, deputy comptroller for the state of Maryland. "We'd be in there auditing."
Darden would not give details, such as how many restaurants its REITs own or in what states, though the company said none of them is in Florida. The company has restaurants in every state except Alaska.
Tax returns are confidential, so it's uncertain how much Darden has saved. The company reported $28.7 million in state and local income taxes around the country last year.
Darden is unusual in that it has disclosed the existence of its trusts, which it formed in 1999, in annual regulatory filings. The company says it does so because it considers them relevant to required disclosures about property holdings and to make investors aware that Darden could use the REITs to potentially raise capital.
Because other companies rarely disclose REITs, experts say, it's uncertain how many use them and how much money they save.
Businesses that use the strategy say they comply with tax laws and take legitimate deductions. But states that have challenged it say captive REITs can be used to illegally distort a company's taxable income.
Lawsuits between the companies and the states show the amount of tax money at stake can be substantial. North Carolina demanded that Wal-Mart Stores pay more than $30 million in unpaid taxes, interest and penalties over four years. Wal-Mart paid, sued to get the money back but lost before North Carolina's Court of Appeals in 2009.
Based on court records in that suit, The Wall Street Journal estimated that Wal-Mart, the world's largest retailer, effectively saved about $230 million in state taxes around the country, about 20 percent of its state tax bills over the four-year period.
In 2005, the Louisiana Supreme Court upheld the state's demand for $1.9 million in unpaid taxes, interest and penalties over three years from car-parts retailer AutoZone.
Maryland over the past few years has collected additional payments from several companies that it has discovered using captive REITs in audits, though the state cannot identify which ones because of confidentiality laws. "It tends to be your big-box companies or your large chains," Tanton said.
Not all states have been successful. In 2007, an appellate court in Kentucky upheld AutoZone's right to deduct REIT dividend payments from its state tax bill.
The practice is so controversial that some state legislatures have passed laws to eliminate the REITs' effectiveness as corporate tax shelters.
Initially created to help small investors put money in a diverse portfolio of property, REITs are the real-estate equivalent of a stock mutual fund. They are required to pay at least 90 percent of their income as dividends to shareholders.