I once spent about 15 minutes wandering up and down the aisles of the Superfresh grocery in Society Hill looking for a bottle of wine. No, I’m not picky. I just didn’t realize that you couldn’t buy wine in the Commonwealth of Pennsylvania outside of the state-operated liquor store system (there is an exception for wineries). That wasn’t the case in my home state of North Carolina. In fact, Utah is the only state in the country that controls wine and liquor sales as much as Pennsylvania.
That might be changing. On Thursday, the Pennsylvania House of Representatives passed a bill that would eventually privatize the sale of wine and liquor in the Commonwealth, something that hasn’t happened since Prohibition. The bill is slated to go to the Senate where it is expected to face fierce opposition.
Leading the charge against the bill is Wendell Young IV, president of the United Food and Commercial Workers Local 1776 and chairman of UFCW of the PA Wine and Spirits Council. Young, and the roughly 3,500 state store employees represented by his union, have decried the move, pointing to concerns about job losses. Democrats in the House also condemned the bill as “bad morally and worse fiscally.”
There have been many missives fired over the bill’s economic consequences but none so laughable as the one hurled this morning over news radio: the privatization of wine and liquor would encourage companies to incorporate in Delaware in order to avoid paying taxes in Pennsylvania.
I hear that a lot, actually, in my line of work. Delaware is a huge draw for many companies because of its business-friendly climate, from strong corporate privacy rules to favorable tax laws. As a result, more than 1,000,000 business entities have their legal home in Delaware including more than 50% of all U.S. publicly-traded companies and 63% of the Fortune 500.
But does that mean it’s an automatic tax suck? Can you really incorporate in Delaware and escape taxation in your home state?
In most cases, the answer is no. It is true that Delaware makes it easy to avoid taxes on certain kinds of revenue streams. Specifically, Delaware does not tax a number of intangibles such as trademarks, royalties, leases and copyrights. That makes it very attractive for certain industries, like IP-heavy companies, software firms and, much to Pennsylvania’s dismay, oil and gas companies, to incorporate and piece out intangibles for purposes of taxation. A Delaware corporation is otherwise still subject to a Delaware state income tax on its taxable income.
With respect to other states, a Delaware incorporation doesn’t necessarily result in zero taxation. States generally impose taxes based on nexus – you might have read about nexus as part of the ongoing battle between internet retailers like Amazon.com and state governments. Nexus is a legal term generally defined as a connection. The degree of connection generally determines the degree of taxation (not always, but you get the idea). Taking into consideration this concept of nexus, factors that figure into whether (and how much) to tax inside a state would include property, payroll, and sales.
That’s where this notion put forth that privatizing the sale of wine and liquor in Pennsylvania would result in a mass exodus of tax dollars to Delaware is seriously flawed. The kind of privatization that’s being touted is brick and mortar based. It’s all about allowing stores on the ground to have licenses to sell wine and liquor outside of the current state-run stores. Taking those three factors into consideration, the property, payroll, and sales remain inside the Commonwealth.
In fact, that tends to be the case more often than not. The reality is that you can’t get away from nexus for many different kinds of businesses. Personal service businesses are, for example, by their very nature, personal. When you go to a doctor’s office or a lawyer’s office, the professional offering those services is physically present at some location: you can’t claim a lack of presence in the state of Ohio, for example, when you’re sitting in your Ohio law office – even if a client never sets foot in your office. Where you perform services matters.
Similarly, where you serve your customers matters. Restaurants, bars, salons, and other location-based businesses have a clear presence. You can’t argue that you have no presence in New Jersey when you have a restaurant serving customers in New Jersey. Similarly, if you sell shoes in a store in Alabama, you have a presence in Alabama.
Where it gets a little fuzzy, as with Amazon, is whether a business has a presence inside a state where the only contact might be a sale over the internet (in most cases, the answer is no). That’s when incorporating in a low tax state may offer an advantage if you can argue that most of your revenue is tied to that location. Similarly, when a revenue stream doesn’t have a logical home – such as a royalty – being able to redirect that revenue to a tax-favorable state makes sense from a planning perspective.
The idea, however, that you can shield every kind of business from tax simply by incorporating in a tax-favored state simply isn’t true. And in a case like the sale of wine and liquor in Pennsylvania, it’s clear that it’s merely a scare tactic to keep lawmakers and taxpayers from changing the status quo.
