The Energy Boom and the Delaware Loophole
Delaware Loophole – Background
Delaware has no corporate tax on income from “non-tangible assets,” such as leases, trademarks, royalties and copyrights.
Large corporations form Delaware subsidiaries and transfer ownership of such assets, then makes steep payments for the use of the assets, making them deductible expenses in Pennsylvania.
The toy store ToysRUs owns a Delaware company called Geoffrey Inc. that collects royalties from local stores for using its giraffe logo.
Most of the Delaware subsidiaries have no employees, and simply exist to collect revenue and redistribute it.
On building at 1209 N. Orange St. in Wilmington, is headquarters for 6,500 registered companies but has only 35 parking spaces.
More than 700 corporations are headquartered in five floors of a downtown Wilmington high rise.
WalMart and Home Depot have real estate investment trusts in Delaware that collect lease payments from local stores.
Delaware’s corporate registry skyrocketed in the early 1990s when corporate accountants began to catch on to using the loophole, peaking two years ago when the state registered 121,000 new corporations – or one per minute of the business day.
With a population one-twelfth the size of Pennsylvania’s, Delaware collects half as much corporate tax revenue, simply from the small fee to register corporations.
Nearly three quarters of Pennsylvania corporations pay no income tax.
Pennsylvania’s revenue department estimated several years ago that combined reporting could bring more than $400 million in tax revenue back to the state.
That loss of revenue contributes to Pennsylvania having the highest corporate net income tax in the nation, an unfair burden to businesses that don’t use Delaware subsidiaries.
The Marcellus Shale/Delaware Boom
According to the Pennsylvania Budget and Policy Center, only 15 percent of 783 Marcellus exploration companies paid Corporate Net Income taxes in 2008.
A significantly larger number of drillers — including nine of the top 10 permit holders in the Marcellus Shale — structure their businesses as limited liability companies (LLCs) or limited partnerships (LPs). This allows them to avoid the corporate net income tax altogether and pay the much lower personal income tax on company profits.
Using the Delaware Division of Corporations on-line database, the Communications and Issues Development Office has identified more than 400 Delaware subsidiaries linked to Marcellus Shale gas exploration.
Nearly half of these companies have been incorporated in the past four years when gas exploration in Pennsylvania began to take off.
According to the Center for Budget and Policy Priorities, there are numerous ways that the Delaware subsidiaries can be used to shift income to tax-free companies in Delaware. They include:
- Royalty payments
- Technology and formula trademarks
- Land leases
Nearly every company drilling, processing or transporting gas in Pennsylvania has at least one, and usually several, Delaware subsidiaries.
One of the largest, Anadarko, has 89 corporations registered in Delaware.
The entities found through the database search represent only companies that can be identified as having the same name as the parent. Perhaps hundreds more exist through other entities, partnerships, mergers and investments.
It is also plausible that the mystery surrounding the actual ingredients and ratios of the fracking fluid are due to corporate trademarks on the formula that are the property of Delaware passive investment companies.
The Pipeline: Examples
Blowout sends frack fluid, stock price soaring — On the day after (April 20) the blowout of a Chesapeake Energy gas well in Bradford County, Reuters reported a multi-national buyout of Frac Tech a fracking company owned partially (25 percent) by Chesapeake. The reported deal would pay Chesapeake cash and increase its stake in Frac Tech to 30 percent. Despite the blown-out well, Chesapeake stock rose nearly 3 percent that day. Nine days earlier, on April 11, a new company appeared at 1209 N. Orange Street in Wilmington – Frac Tech International LLC. It joined siblings Frac Tech Services (9/29/10) and Frac Tech Horizons (12/29/06) at that location.
A birth in the family – In January of 2009, MarkWest Energy Partners, L.P. and NGP Midstream & Resources, L.P., announced the formation of a new company to build a gas processing plant in Southwestern Pa. The first work was done in Delaware, where the new venture — MarkWest Liberty Midstream & Resources, LLC – was incorporated at 1209 N. Orange St. on Jan. 20. 2009. Four months later, the facility opened in Washington County, PA. MarkWest has 17 entities registered in Delaware; NGP has as many as 100.
Too much paperwork — While the drilling companies have been aggressive at keeping up with the paperwork for hundreds of corporate subsidiaries, they have not been so productive with state regulators.
In 2010, 41 of 74 companies missed the August 15 deadline for filing production reports with the state Department of Environmental Protection.
Two of those companies was Carrizo (Marcellus) LLC and Carrizo Oil and Gas, according to DEP. Carizzo was busy giving birth to a new Delaware subsidiary (Carrizo Marcellus WV LLC) on August 18, 2010. Nine days after the deadline, Carrizo still had not filed its production report in Pennsylvania.
It’s the same story for Atlas Resources which skipped the DEP deadline, but filed a new subsidiary in Delaware, Atlas Resources Series 29-2010 LP, on August 17, according to the Delaware Division of Corporations.
EXCO Holding PA Inc. is registered in Delaware….Penn Virginia has 14 Delaware entities, all at 1209 N. Orange St…..PVR Radnor is not in Radnor. It’s in Delaware at 1209 N. Orange, but so is PVR North Texas and PVR Lexington and PVR Savannah….Range Resources is perhaps the granddaddy of them all, having been registered in Delaware for more than 30 years, but there have been lots of new kids on the block at 2711 Centerville Road.
Sen. Tartaglione is asking the Department of Revenue to audit the general activity of companies listed on the latest Department of Environmental Protection Marcellus Production Report as they relate to expenses charged to Delaware corporations.
In the fall of 2010, there were 74 companies listed on the report.
In a letter to acting Secretary of Revenue Dan Meuser, senators will seek a report on corporate net income taxes paid for 2010 by these companies, including:
- Total deductions taken for expenses to out of state companies
- Total deductions taken for expenses to Delaware companies
- A good-faith estimate of revenue that could be recovered by requiring combined reporting
Sen. Tartaglione is calling for immediate consideration of Senate Bill 679, requiring “combined reporting” to close the loophole.
Five years ago only 16 states, representing 29 percent of the U.S. economy used combined reporting. Now 23 states have adopted the practice – representing nearly two-thirds of of the economy.
Combined reporting would add little to corporate accounting because three quarters of companies that would be affected already do business in states that require combined reporting.
Between 1990 and 2007, of the eight states that saw manufacturing job gains, seven required combined reporting.
Most of the large corporations that would be affected by reform in Pennsylvania maintain facilities and workers in numerous combined-reporting states year-in and year-out.