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Yesterday's Senate Post-Audit and Oversight Committee hearing on tax incentives in general and, in particular, two companies — Fidelity and Evergreen Solar — generated a lot of testimony about some very arcane aspects of tax policy set out in state law.

DOR Commissioner Navjeet K. Bal, for instance, will likely never again have the honor of presenting testimony explaining the single sales factor and the concept of tax apportionment before a jam-packed audience of legislators, staffers, business types and media in State House Room 222 yesterday.

In 1996, the Massachusetts Legislature and Gov. William Weld decided to treat the business income of certain mutual fund service corporations (those with a physical presence in Massachusetts and sales both in and out of state) the same as defense corporations or manufacturers — that is, to determine the tax owed based solely on the sales of the business, and not has had been the case, on a three-pronged apportionment factor based on sales, payroll and property.

Furthermore, in the case of mutual fund service corporations, the Legislature also changed the way their sales were sourced. That meant that sales by mutual fund service corporations to the mutual fund itself were sourced based on where the shareholders (or investors) in that mutual fund were located, as opposed to where the mutual fund company itself was located.

In the case of mutual fund service corporations, these twin changes in tax law served to lower corporate taxes. The shift to the single sales factor meant that property and payroll in Massachusetts were no longer part of the calculation of determining taxable income, a change designed to encourage mutual fund service corporations to locate in Massachusetts. Similarly, the change in sourcing lowered the Massachusetts tax liability by spreading those sales around the country. That was another tax incentive to locate in Massachusetts.

The 1996 law included provisions for increased hiring, but those provisions expired in 2002, meaning that since then, every mutual fund service corporation receives the single sales factor and destination sourcing tax treatment regardless of employment levels. That, simply put, is the law.

According to aggregate reports DOR prepared during the period from 1997 through 2001 for the mutual fund service corporations that qualified by virtue of increasing their employment by 5 percent annually, Massachusetts employment levels in the industry rose from 40 companies employing 16,562 in 1997 to 50 companies employing 24,379 in 2000 dropping down to 36 companies employing 19,233 in 2001, which coincides with a stock market decline (the dot.com bubble). As this Bloomberg News story shows, Fidelity defended its job creation record at yesterday's hearing.

Over the years, DOR has compiled estimates of the revenue impact of the single sales factor for both manufacturers and mutual fund service corporations. In the case of mutual funds, destination sourcing and the single sales factor have saved companies about $1.7 billion in taxes since 1996, while the single sales factor for defense contractors and manufacturers have saved those companies about $1.2 billion in the same time period.

These are large numbers, but for context it is important to point out that the Tax Expenditure Budget, the annual document that estimates all revenue foregone as the result of tax law changes, exemptions, deductions and credits, estimates more than $24 billion in such tax expenditures will be recorded in FY12 alone.

 

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