Foreign operating corporation taxes at heart of tax bill agreement

The main provision at stake in the compromise deals with foreign operating corporations or FOCs. Tax breaks for companies with operations abroad have been in place since 1988. As Charlie Weaver of the Minnesota Business Partnership puts it, the law was originally intended to level the playing between foreign companies and homegrown companies that want to do business overseas.

Weaver says at the time, foreign companies operating in Minnesota were getting a better tax treatment than homegrown companies making a profit abroad.

"So if you opened a subsidiary, say in India, you were penalized, prior to the passage of the law, for bringing that money back to Minnesota," according to Weaver. "You'd just leave it over there. So this allowed you to bring the money back, and only about 20 percent of it was taxed. And it was seen then as helping large Minnesota companies that were operating internationally compete."

In 2005, lawmakers changed the law to prevent companies from creating "shell" corporations overseas. FOCs now have to have $2 million of property located outside the U.S. and $1 million in payroll outside the U.S. That way, companies can't just set up offices overseas that are essentially a post office box in order to reap the tax benefits.

But even with the rules tightened, Minnesota Revenue Commissioner Ward Einess says there remains some doubt about how companies use the FOC tax shelter.

"The concern has been that the income that's flowing through the foreign operating corporation is not foreign income," he said. "It's actually domestic income."

Einess says that the Department of Revenue never fully ascertained that any of the 200 or so companies operating FOCs actually were circulating domestic income through the foreign subsidiaries, but the concern was out there.

DFLers wanted to close any possible loophole, which would generate $244 million. They wanted that money to help fund property tax relief.

During budget negotiations early Monday morning, the governor apparently accepted changes that raised about half of the original $244 million. Legislators agreed to a delayed implementation of the restriction. And they agreed to offer two other business tax breaks, which target taxes on royalties, and a tax apportionment formula called "single sales."

"We combined these two proposals, to get everywhere to where we need to go," said Rep. Ann Lenczewski, DFL-Bloomington, the chair of the House Taxes Committee. "The House and the Senate have been trying to get these foreign operating corporation problem dealt with for a long time. It was a huge success to get this done."

Detractors to the proposed changes to the rules concerning foreign operating corporations say they might hurt business.

Tom Hesse, of the Minnesota Chamber of Commerce, says the proposed legislation will have a varied impact on companies, depending on how they're structured. But overall he doesn't like the dichotomy it sets up because it penalizes profits earned in the U.S.

"The Legislature has, for some reason, determined that if an FOC has earned some from domestic sources, from United States sources that's bad, and if you earn income from foreign sources, that's good," he said.

Even with agreement reached on the corporate tax provisions, it's not clear that the governor will agree to sign the overall tax bill.