By Sandra Pedicini and Jason Garcia, Orlando Sentinel
10:04 PM CDT, May 30, 2011
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.
Businesses routinely seek ways to lower their taxes. And a number of multistate retailers, including Wal-Mart and AutoZone, also have used company-owned trusts — often referred to as "captive REITs."
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.
A REIT pays no corporate income tax on any profits distributed as dividends, under the presumption that shareholders will pay personal income tax on the money. That provides an opening for businesses that create their own REITs.
Darden has acknowledged it operates REITs in a similar manner to other companies that experts say have used them to cut taxes.
Darden's REITs own some of its restaurants. Darden then rents those restaurants back through operating entities. The company takes deductions on the payments in those states.
The REITs then pay dividends back to Darden in Florida, where the company avoids increased taxes from that income by canceling it out with the expenses of renting restaurants in other states. It can do that by filing a single, combined tax return in Florida for itself and its various subsidiaries.
The strategy is a "completely circular shifting of income," said Michael Mazerov, a senior fellow with the Center on Budget and Policy Priorities in Washington, D.C. The liberal-leaning research group encourages states to crack down on corporate tax shelters.
Darden says its strategy does not cost Florida anything because its REITs don't own any restaurants in this state. Florida levies sales tax on commercial rent — including rent paid from one company subsidiary to another — which experts say would offset any corporate-income tax savings gained through a rental REIT.
Experts say the use of REITs doesn't affect federal income taxes, because the federal government taxes dividends paid to corporate owners.
Captive REITs are one of a number of so-called "tax planning" methods that experts say have contributed to erosion of corporate taxes around the country. From 1992 to 2009, state corporate income taxes fell from 4.4 percent of total corporate profits to 3.07 percent, according to the Center for Business and Economic Research at the University of Tennessee.
Darden made $407 million in profit from continuing operations last year, after an income-tax expense of $136.6 million. The vast majority of that tax bill was in federal taxes.
The company has steadily whittled its tax rate over the years. Annual reports show that its effective income-tax rate — the rate at which it actually pays state and federal income taxes, after factoring in credits and other deductions — has dropped from 35.5 percent to 25.1 percent over the past decade.
The company says the decrease is primarily because of federal wage-related credits and hiring incentives, as well as deductions for charitable giving.
This spring, the company got a break from the Florida Legislature allowing it to extend the life of corporate-income tax credits associated with an incentive package it got to stay in Orange County and build its new corporate headquarters here. Darden said it had been unable to realize the full value of those tax credits so far, because it wasn't paying enough in Florida corporate income taxes.
"Darden's goal is to grow as a business, and we have a fiduciary responsibility to our shareholders to manage our resources responsibly as we execute our formula for growth," the company said in an email. "One of the many ways we do that is by working to achieve a low effective tax rate. By doing so, we are able to reinvest in that growth; in turn creating more jobs, more opportunities for our employees and more value for our shareholders."'
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