With only days left in the 2019 legislative session, Colorado lawmakers were presented with an extraordinary plea from the Polis administration: Pass a law to help the state’s Department of Revenue win an obscure corporate income tax lawsuit, or risk losing hundreds of millions of dollars to what it viewed as a tax loophole for shell companies.
At an April 30 committee hearing, Democratic bill sponsor Rep. Matt Gray put it in stark terms: “That’s the entire all-day kindergarten budget, plus some.”
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The bill’s nonpartisan fiscal note even generated little attention. It predicted no impact on state revenue — but with one major caveat: If the Supreme Court ruled against the state in a pair of pending legal cases, the impact could be significant — costing the state upwards of $100 million a year in lost tax revenue, plus as much as $250 million in disputed tax returns from years past. For context, full-day kindergarten initially was estimated to cost the state $227 million a year if implemented in every school district.
The Democratic-led legislature approved the measure on final passage the day before the session ended, capping a frenzied eleventh-hour push by the Polis administration that angered business groups and raised eyebrows in the legal community. Ultimately, lawmakers stopped short of the sort of declaration that Polis wanted, opting instead to simply change the law to provide more clarity to businesses in the future.
After that late compromise was struck, the state’s largest business group, the Colorado Chamber of Commerce, dropped its opposition. Nonetheless, the process left much to be desired in the eyes of some business advocates.
“If this was a significant concern by the administration, by the department, a bill should’ve been brought much sooner in the legislative process,” Loren Furman, the chamber’s chief lobbyist, said in an interview. Furman said Department of Revenue officials meet with a coalition of business and tax experts before each session to discuss important legislation, but stakeholders received no advance warning of the measure before it was introduced April 2, a month before the end of the session.
The Colorado Department of Revenue referred questions to the governor’s office for comment. Gov. Jared Polis’ office did not respond to an interview request Monday.
A Polis spokeswoman issued a statement that did not address The Colorado Sun’s questions and called it common to “clarify statutes when they become the subject of litigation.”
The Colorado Bar Association, however, told lawmakers it was an inappropriate time for the legislature to weigh in, citing the pending Supreme Court decision.
The episode casts a broader light on the lengths to which the Polis administration is willing to go in pursuit of one of its top priorities: Eliminating what it views as corporate tax loopholes that benefit some businesses and take away state revenue.
State taxes stop at the “water’s edge”
The legislation was designed to give the state a last-minute edge in two lawsuits, brought years ago by Oracle Corp. and Agilent Technologies Inc. The companies protested a pair of state audits that faulted the companies for not including some of their holding companies when calculating their income tax bills.
The corporations argue they don’t have to, because they fail a key test in state law: To be included in a combined report, a holding company has to have more than 20 percent of its payroll or property within the United States.
This is known as the “water’s edge” doctrine, and was added to state law in 1985. Current state revenue officials told lawmakers that the purpose was to prevent unfair taxation of foreign holding companies that don’t do much, if any, business in the United States. In other words, Colorado taxes end at the proverbial “water’s edge” — the country’s borders.
But it’s not that the disputed holding companies are necessarily operating predominantly in foreign countries — they just don’t have any property or payroll at all. State revenue officials say they have long interpreted that to mean the “water’s edge” exemption shouldn’t apply. But the state’s courts disagreed, ruling at the district and appeals level that having no payroll or property means the holding companies don’t meet the 20 percent threshold established by state law.
Lawmakers divided over “legislative intent”
As introduced, the bill would have written into state law what the Department of Revenue has long considered state policy: The “water’s edge” exemption shouldn’t apply to shell companies without any payroll or property at all.
But it also would’ve gone a step further, declaring that this interpretation was the legislature’s intent all along — dating back to 1985 when the law was first adopted.
“Our argument was if you want to change the statute, fine, but don’t try to reinterpret what the statute meant in 1985,” said Furman, the Colorado Chamber lobbyist.
Some lawmakers agreed, and wanted to defer to the Colorado Supreme Court, which had oral arguments on the case days after the bill was introduced. “Seems to me that the Colorado Supreme Court should be the proper authority to establish what the intent of the law was,” Rep. Rod Rod Bockenfeld, a Watkins Republican, said at a committee hearing. “Why are we interfering with the judiciary?”
Gray disagreed, saying that some judges, including Chief Justice Nathan Coats, actually asked for the legislature’s opinion on the matter. That doesn’t mean, Gray added, that the legislature could tell the court how to rule.
“We would be one voice,” the Broomfield Democrat said at the hearing. “There would be many other voices.”
Ultimately, majorities in both chambers agreed to remove the legislative intent language from the bill. If Polis signs it into law, Colorado will require such shell companies to pay income taxes moving forward.
If the Supreme Court rules for the state, the bill would be rendered moot — that’s why the fiscal note didn’t predict a change in revenue. But legislative economist Larson Silbaugh noted, if the court ruled against the state, the impacts could be significant.
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There’s $35.9 million at stake in the two court cases, he told the House Appropriations Committee, and more than a dozen other companies have filed amended returns that could result in an additional $215 million in tax refunds if the state loses. And that total could grow, if more companies file amended returns after learning about the case. Taxpayers can’t recover overpaid taxes dating back to 1985, but they could request up to four years of refunds, Silbaugh said.
If the state loses the court case, the bill could also prevent in the neighborhood of $100 million annually in lost taxes in the future. That’s money the state expects to get under current policy, which the bill codifies into law. But the projections are murky. Silbaugh told committee members he didn’t have good estimates, and the governor’s office did not respond to The Sun’s request for information.