Academic journal article ABA Banking Journal

Cross a Border, Pay More Taxes?

Academic journal article ABA Banking Journal

Cross a Border, Pay More Taxes?

Article excerpt

What do offering credit ards, selling Federal funds, buying secondary mortgage market securities, taking deposits from interstate commuters, and participating in multibank loans have in common?

They're all among the services that could expose banks of all sizes to income tax liability in another state-although they have no office in that state-under a relatively new concept in financial institution taxation. It is called the "market state" approach.

A federal matter. Though state taxes are at issue, several factors make this a federal-level concern.

One is constitutional. Opponents of the new approach, including ABA, believe the concept violates the Constitution's "commerce clause" on several grounds. That clause puts control of interstate commerce in the hands of Congress.

Another reason is that, in the absence of some common blueprint, states could consider the market state approach a way to raise revenues and produce a patchwork of laws that could make Internal Revenue Service taxpayer compliance reporting look simple by comparison. Further, ABA believes, this patchwork could lead to some income being taxed twice-both by the bank's home state and the state imposing market state taxation.

ABA has called for a two-year federal moratorium during which state tax administrators and the industry could explore the ramifications of the idea. Also, the association has generally endorsed an American Bar Association draft law setting out jurisdictional boundaries for state taxation of nonresident depository institutions. Building interest. Several states have already adopted the market-state concept. They include Minnesota, in 1987; Indiana, in 1989; and Tennessee, in 1990. Other states are considering the issue.

Increasing bankers' concern are the moves of the Multistate Tax Commission, an interstate organization. The commission has proposed a model rule called the Financial Institutions Allocation and Apportionment Regulations. Its intent is to create a uniform method of computing income taxes for institutions that have a physical presence in a state. As it is, the methods used in the three states mentioned differ from each other and from the interstate body's proposed model.

In brief, the commission's proposal would allow a state to tax the local income of out-of-state banks without offices in that state. This circumstance would be triggered in either of two ways. One would be having 100 or more customers residing in that state. Alternatively, state taxes would kick in if the out-of-state bank had $10 million in deposits or assets in that state.

Adding to the confusion and to ABA's concern, however, is that only 22 states belong to the commission. While some other states are associate members, many have no affiliation with the group and can proceed as they like. Banking objections. The multistate commission is holding a series of hearings on its proposal. Paul Claytor, managing director of corporate taxes for Chicago's Continental Bank, testified for ABA in late August. Claytor, then chairman of ABA's Taxation Committee, raised three major objections:

(1) It fails to provide a mechanism to prevent multiple taxation of the same income.

(2) It represents a barrier to interstate flow of funds.

States that adopt market state taxation, Claytor explained, would find banks either covering their increased costs through higher prices or, where interest-rate controls and the like don't allow this, pulling out of that state. Thus, ABA worries that banks' ability to diversify their geographic risk would be hampered.

(3) It could, from the states' perspectives, end up a wash as neighboring states enact similar plans. In addition, the cost of auditing out-of-state banks' tax compliance could exceed the tax revenue gained.

At the same time, the cost of revamping or replacing accounting systems to isolate business conducted with customers in other states would be extremely costly to banks. …

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