February 9, 2011
Corporation Business Tax: "Geoffrey's Loophole"
You asked for an explanation of the tax planning strategy known as “Geoffrey's Loophole. ”
“Geoffrey's Loophole” involves lowering a corporation's tax liability by shifting income to subsidiaries located in low or no-tax states to avoid including it in income subject to taxation in the taxing state, while at the same time generating tax deductions in the taxing state for royalty and interest expenses and deductible dividends.
The most well-known example of this strategy involves Toys R Us and its corporate trademark Geoffrey the Giraffe, as illustrated in the following example:
1. Toys R Us creates a Delaware holding company subsidiary (DHC), as Delaware does not tax royalty or interest income.
2. The Toys R Us DHC rents an office in Delaware and hires one part-time employee.
3. Toys R Us transfers ownership of its corporate trademark – Geoffrey the Giraffe – to the DHC.
4. The DHC charges Toys R Us a royalty of 1% of its annual sales to use Geoffrey.
5. Toys R Us deducts the royalty expense from its gross income for Connecticut corporation tax purposes.
6. The DHC's royalty income is not taxed in Delaware.
7. The DHC can return its income to its parent Toys R Us in the form of a loan or dividends.
8. Toys R Us can deduct the interest payable on the loan and the intercompany dividends from its income, thus reducing its Connecticut corporation tax liability.
This strategy does not affect Connecticut sales and use tax collection requirements, which still must be charged and remitted on purchases made in Connecticut or that are made online and shipped to Connecticut.
I hope that you find this information helpful. Please contact me if you have any questions or need further assistance.