By Sheldon Pollack From Delaware online

In recent years, the United States has campaigned against international “tax havens” that assist multinational corporations in reducing their U.S tax liabilities. This is accomplished by shifting U.S. profits to a low-tax jurisdiction such as Bermuda or the Cayman Islands. The Treasury Department also has been attacking the use of secret bank accounts in places like Switzerland, Luxembourg and the Isle of Man.

Secret bank accounts allow tax scofflaws to hide assets from the Internal Revenue Service and criminals to stash profits from illegal activities such as the drug trade and offshore gambling. Some jurisdictions conveniently provide the benefits of both low taxes and bank secrecy. Think of Bermuda and the Cayman Islands. Plus they make for a nice place to visit your money during the cold winter.

Because of the campaign against international tax havens and bank secrecy, there is rising resentment against Uncle Sam in certain quarters in Europe. This resentment is fueled by stories that appear in the American press every few years proclaiming the state of Delaware a tax haven and purveyor of clandestine “shell corporations” for illegal money-laundering. Based on a misunderstanding of Delaware’s tax law, these exposes portray the First State as a leading international tax haven.

Journalists commonly cite the large number of publicly traded corporations organized under Delaware law as evidence that the First State is a haven for corporate tax cheats. Why else so many Delaware incorporations? They also point to the privacy afforded to the owners of Delaware closely held corporations as evidence that Delaware is a place to launder profits from illicit enterprises.

Taking the cue from their U.S. brethren, European journalists point to Delaware as confirmation of American hypocrisy –railing against European tax havens and bank secrecy while the worst culprit is located in the United States. That would be Delaware.

In recent years, reporters from United Kingdom newspapers, the BBC and Swiss TV have descended on the First State looking to expose Delaware for its lax corporate statute and favorable tax climate for multinational corporations.

But these reporters do not grasp the subtle distinction between Delaware as a domestic tax haven, which costs other U.S. state’s millions in tax revenue, and jurisdictions such as Ireland, the Isle of Man, Jersey, Bermuda, and the Cayman Islands, which are international tax havens that cost the U.S. and European treasuries billions in tax revenue.

They are convinced that Delaware is an international tax haven and facilitator of money-laundering.

What is it about Delaware tax and corporate law that gives rise to the image of Delaware as a tax haven and renege state?

Delaware is a Domestic Tax Haven. As is well known among tax lawyers, Delaware is a domestic tax haven. The state provides an infamous exemption from its corporate income tax for so-called Delaware investment holding companies. This is a Delaware corporation whose activities are limited to holding intangible assets.

Long story short, this is a time-honored sham (oops, I mean “tax planning strategy”) perpetrated by the legislature of the state of Delaware on the treasuries of its sister states.

How does it work? A corporation physically located and doing business in another state (say, Pennsylvania) creates a Delaware investment holding company as a subsidiary to hold its intangible assets (e.g., intellectual property such as patents, trademarks, trade names, etc.). The intangible assets become the property of the Delaware subsidiary. The Pennsylvania parent then shifts profits to its exempt Delaware subsidiary by paying licensing fees for the right to use the intangible property.

It is a bit more complicated than that, but there is no shortage of attorneys and accountants in Wilmington willing to explain the subtleties and set it up – for a fee, of course. The objective? The earnings derived from the intangible assets escape Pennsylvania corporate income tax (which peaks at an onerous rate of 9.99 percent), while Delaware graciously forgoes taxing the same income under its corporate income tax.

What’s in it for Delaware, if the income is not taxed? Some franchise tax is collected by the state on the investment holding company, but the real benefit is the fees generated for Delaware lawyers and accountants. Not surprisingly, the tax authorities in places like Harrisburg are not so happy about the arrangement.

Some states have responded, looking to close the loophole. After suffering for decades, Pennsylvania enacted legislation last year to close the “Delaware loophole.” Such measures are unlikely to do much to either close the loophole or stifle resentment against Delaware among its neighbor. It does not help that Delaware does not impose a retail sales tax – luring shoppers off I-95 who might otherwise spend their hard-earned dollars in places like Pennsylvania. This reinforces the perception that Delaware does not play fair with taxes. Sort of right.

Delaware is Not an International Tax Haven. Foreign journalists cite well-known statistics that more than half of publicly traded corporations in the U.S. are organized as Delaware corporations.

A lot of privately held businesses located and doing business in other states are also organized as Delaware corporations – although for no obvious reason or benefit. Journalists take this as definitive proof that Delaware is a tax haven.

Why else would all these corporations organize under Delaware law? Must be the tax benefits. But the reason is more complicated. Delaware has a modern corporate statute, settled case law, and a specialized court (Chancery) that routinely deals with issues of corporate governance.

The published decisions of the Delaware Supreme Court on matters involving corporate governance are also widely read, respected and followed.

There is disagreement among scholars as to whether the corporate law is more favorable to management than that of other jurisdictions or whether the benefit is simply that legal outcomes are more predictable. Regardless, a corporation organized under Delaware’s corporate statute is subject to Delaware law, and a lot of folks think that is beneficial. That is why so many public corporations are organized under Delaware’s corporate statute. Nothing to do with reducing federal or state taxes.

Certainly, no multinational corporation would ever want to shift taxable income from Europe to Delaware – where it will be exposed to the 35 percent federal corporate income tax (one of the highest in the world) and Delaware’s 8.7 percent corporate income tax (no bargain either). That is why so many multinational corporations bend over backward to shift income out of the United States and states like Delaware to offshore tax havens such as Bermuda, the Cayman Islands or the Isle of Man.

Or perhaps to Ireland, where Apple moves a lot of the income it earns from selling millions of iPods and iPhones to Americans. Starbuck’s does the same. But never to Delaware. That tells you something. Has anyone ever heard of Apple or Starbuck’s engage in tax planning to shift revenue from Ireland to Delaware? That would be a major tax boner.

Confidentiality Does Not Facilitate Money-Laundering. It is true that Delaware provides some greater privacy as to the identity of the owners of privately held corporations than do most states – except for Nevada and Wyoming, which ask no questions. Does that facilitate money-laundering? Doubtful. State authorities and law enforcement can always gain access to that information.

Furthermore, states that require the names of the owners of a new corporation to be disclosed on their corporate charters do no further investigation and certainly do not monitor the comings and goings of shareholders. Anyway, you can always use a Bermuda or Caymans Island corporation to hold the shares of a Pennsylvania or New York corporation, thereby shielding the true identity of the owners.

It isn’t hard to keep that information secret in any state. True, it is a bit easier in Delaware, but that does not facilitate illegal money-laundering.

Rather because Delaware corporations are easy and cheap to organize, a would-be money-launderer is more likely to use a Delaware corporation for nefarious purposes. That does not make Delaware a renegade state. But pointing fingers at Delaware makes for a good story for foreign journalists and lends credence to the bogus claim that the U.S. government is hypocritical in criticizing banks in Switzerland for aiding and abetting tax cheats and money-laundering.

So expect more stories about Delaware as an international tax haven and a good place to laundry cash. But don’t believe everything you read about the First State in the UK newspapers or on Swiss TV.

Sheldon D. Pollack is professor of law and political science at the University of Delaware.

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For more on this story go to: http://www.delawareonline.com/story/opinion/contributors/2014/07/12/delaware-tax-haven-maybe/12551227/