Wisconsin banks with out-of-state investment subsidiaries could face bigger tax bills in the coming months if state auditors determine that the units were created chiefly to avoid taxes.
Diane L. Hardt, a tax administrator for the Wisconsin Department of Revenue, said it is auditing about 30 banks that have set up investment subsidiaries in Nevada, which does not have a state income tax.
The subsidiaries hold and manage investments for the banks and in some cases buy loans from the banks, either individually or as mortgage-backed securities. The department began the audits last year after general audits in previous years raised questions about how banks were reporting income and expenses from the subsidiaries.
A number of states have been looking to close the tax loopholes banks have exploited through subsidiaries. Massachusetts, Hawaii, and California have recently taxed banks on real estate investment trust subsidiaries. In Massachusetts and Hawaii, banks were claiming deductions twice on the dividends paid from REITs, and California said banks were not reporting REIT dividends as income on their state tax returns when they should have.
Bankers in these states have said the increased scrutiny is meant to help erase budget deficits, though that does not seem to be the motivating factor in Wisconsin. It was facing a projected $3.2 billion shortfall for its latest biennial budget, which Gov. Jim Doyle signed in July, but the budget was balanced through program cuts.
Ms. Hardt could not say how much money the banks might have to pay, but banks say they are concerned the audit could result in significant assessments. In its fourth-quarter earnings release Jan. 21, the $3.1 billion-asset Bank Mutual Corp. of Milwaukee told investors the state is auditing its Nevada subsidiary. Taxing the unit's income would have "a substantial negative impact on the earnings," Bank Mutual said.
Banks would not say how much they save by having the out-of-state operations, but a press release from state Rep. Spencer Black in June said 10 of the state's 13 largest banks paid no income tax in 2000. Wisconsin's corporate income tax rate is 7.9%.
Harry J. Argue, the executive vice president and chief executive officer of the Wisconsin Bankers Association, said at least 60 banks have set up such subsidiaries. The fact that the number has grown over the past two years is one reason for the attention they are getting, he said.
Ms. Hardt said the tax status of these subsidiaries has been an issue for years, and some banks even asked the Department of Revenue for letters to clarify what the tax status of such units would be as they were set up.
Mr. Argue said the department is looking to see whether the banks that received the letters have stepped outside the bounds of the letters.
"Our banks believe the subsidiaries they have are operating within the boundaries of state law and the boundaries of the interpretive letters," he said. "It's a case of banks operating within boundaries of a law that is unusual."
However, Ms. Hardt said the audits are not focused on banks that asked for rulings on the tax status of their units.
In October 2002, the department said in a press release that certain characteristics in subsidiaries would lead to audits.
The department said it would look carefully at banks that have subsidiaries in states without an income tax. It would also look at banks that transfer large numbers of loans to subsidiaries, whether directly or through vehicles like mortgage-backed securities, and banks that keep the servicing of transferred loans in Wisconsin.
It also said large amounts of capital coming from a subsidiary to a parent by dividends, returns of capital, or other means would raise a red flag.
Daryl Ohland, a senior manager for state and local taxes at the Appleton office of Grant Thornton LLP, said subsidiaries have become an issue in Wisconsin because it is a "separate return state," in which each entity owned by a company files an independent tax return. Most other states consolidate the income of a parent company and its units for tax purposes.
In 1999, when then-Gov. Tommy G. Thompson proposed a change in the law to move to combined reporting, the Milwaukee Journal Sentinel reported that Marshall & Ilsley Corp. said it saved between $9 million and $13 million of taxes annually from the arrangement.
If the Nevada subsidiaries function as separate entities, Wisconsin would not assess taxes on them, Mr. Ohland said. The current audits are meant to determine if the units function as separate businesses.
Ms. Hardt said the department is looking at how banks match their income with their expenses.
If a bank's expenses were all coming from its Wisconsin operations and its revenues were all coming from a Nevada subsidiary, the Department might reconsider whether the subsidiary ought to pay Wisconsin tax, because its connection with Wisconsin would be significant enough to warrant taxes, she said.
