Path for Skirting U.S. Taxes Widens With REIT Blueprint

Photographer: Paul Taggart/Bloomberg

An International Paper Co. factory in Mt. Carmel, Pennsylvania. Close

An International Paper Co. factory in Mt. Carmel, Pennsylvania.

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Photographer: Paul Taggart/Bloomberg

An International Paper Co. factory in Mt. Carmel, Pennsylvania.

Getting a foreign address isn’t the only way American companies are skirting corporate income taxes.

Even as President Barack Obama calls for rules to stop companies from ditching tax bills by reincorporating abroad, the byzantine U.S. tax code is offering new techniques to escape the highest corporate rate in the developed world.

The shares of the biggest U.S. phone companies, including AT&T Inc. (T) and Verizon Communications Inc. (VZ), rose today amid prospects the Internal Revenue Service will allow them to pursue another tactic: placing some operations in tax-advantaged vehicles known as real estate investment trusts, or REITS. Last week, shares of containerboard makers such as International Paper Co. (IP) soared on speculation they will use another tax-free structure known as a master limited partnership, or MLP.

Companies are finding all kinds of ways to escape America’s 35 percent corporate rate, from acquiring a mailbox in Ireland to using a 54-year-old tax break originally meant to allow middle-class people to invest in real estate.

The use of foreign addresses, known as “inversion,” is getting increasing attention in Washington this year as corporations like Pfizer Inc. (PFE) and Walgreen Co. (WAG) consider such a move. Congressional Democrats held a press conference today to announce a new proposal to deny government contracts to some inverted companies, and Obama last week labeled such companies “corporate deserters.” Orrin Hatch, the top Republican on the Senate Finance Committee, said last week he may be open to short-term action to address inversions.

Tax Dodges

“It just seems like every few days there’s an effort to try to invent yet another tax dodge,” Senate Finance Chairman Ron Wyden, an Oregon Democrat, told reporters at the Capitol today. “If you just sit on the sidelines and let that happen, you’re going to have two sets of tax rules in America -- one for the people who think up these tax dodges” and one for everyone else, he said.

U.S. Treasury Secretary Jack Lew, traveling today in Iowa, said it’s urgent to prevent inversions. “We are going to work as hard as we can and look at every tool that we can use to make the law different so that this cannot happen,” Lew said.

Meanwhile, there’s little sign of a legislative threat to the use of so-called “pass-through” companies, such as REITs and MLPs, neither of which pay corporate income tax. Instead, their owners pay individual taxes on their share of the company’s income.

One of the few Democratic proposals regarding pass-throughs to get attention in recent years is one to expand the MLP rules to benefit renewable energy providers.

REIT Expansion

A draft plan from Republican House Ways and Means Chairman Dave Camp earlier this year would have prevented corporations from using tax-free spinoffs to create REITs. That and other related changes would have raised $5.9 billion in revenue over a decade. Camp’s plan also would have prevented private equity firms from being publicly traded partnerships.

The use of both REITS and MLPs has exploded in recent years, partly because of IRS rulings that allowed more and more companies to take advantage of them. Authorized under a special exception to a 1987 tax law, until recently MLPs were mostly used to hold oil and gas pipelines.

Now, in addition to pipeline giants like Kinder Morgan Energy Partners LP (KMP), the ranks of publicly traded partnerships include Blackstone Group LP (BX), the leveraged-buyout firm.

First authorized by law in 1960, REITs have enjoyed a similar expansion, as the IRS has ruled more and more companies’ activities qualify as “real estate.” These include Corrections Corp. (CXW) of America, the private prison operator, and American Tower Corp. (AMT), which owns wireless communications towers.

Windstream Ruling

Today’s surge in telecommunications stocks was fueled by news that Windstream Holdings Inc. (WIN), a Little Rock, Arkansas-based phone company, won a ruling from the IRS that a new vehicle holding its fiber and copper networks would qualify as a REIT. Last week, Memphis, Tennessee-based International Paper’s stock rose after a hedge-fund manager bought several containerboard companies and urged them to reorganize as MLPs.

The message from the IRS’s Windstream decision today “is that the technique is now widely available to any company that has real estate,” said Robert Willens, an independent corporate tax consultant. “This could include McDonald’s, J.C. Penney (JCP), utility companies, cable companies.”

The IRS has shown increasing “open-mindedness” in rulings that allow companies to spin off REITs, said Robert Wellen, a partner at Ivins, Phillips & Barker in Washington. The spinoffs have double advantages because investors are familiar with and attracted to REITs as an asset class, he said.

REIT Types

“You can attract that segment of the market and raise capital that way, and obviously the tax benefits are very important,” Wellen said.

The IRS may not have been asked until recently to consider REITs composed of assets such as casinos and cable lines, Wellen said. “Clearly they’re receptive to these innovative REIT structures,” he said. “How far this will go, who knows?”

The exodus from the U.S. corporate tax system puts more pressure on the companies that remain.

Ken Frazier, the CEO of Whitehouse Station, New Jersey-based Merck & Co. (MRK), said he hopes Congress will act, especially as Pfizer and other competitors look for a way to leave and gain an advantage.

“We would be concerned if other companies had an advantage on us,” he said in a telephone interview today. “We’re trying to get Congress to look at how all U.S. firms are at a huge disadvantage. Our belief is that a rational society will eventually get around to tax reform.”

To contact the reporters on this story: Zachary R. Mider in New York at zmider1@bloomberg.net; Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editors responsible for this story: Kevin Miller at kmiller@bloomberg.net; Daniel Golden at dlgolden@bloomberg.net James Callan

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