Net Sum Zero
Mr. J. Wayne Leonard, CEO
Entergy Corporation
639 Loyola Avenue
New Orleans, LA 70113
Dear Mr. Leonard:
Now that Governor James Douglas has decided to veto the climate change bill, Entergy Corporation will be on the receiving end of some very nasty rhetoric when the Vermont Legislature reconvenes on July 11th.
My intent in writing this letter is to relate a true story that occurred in Brattleboro twenty-five years ago that may assist Entergy in your upcoming dispute with the legislature. The secret agreement between a Brattleboro manufacturer and the Vt. Dept. of Taxes can now be revealed because the company no longer exists and its principles are deceased.
The sequence of events that unfolded may provide an effective game plan that Entergy can use whether or not the legislature is successful in overriding Gov. Douglas’ veto that will tax Entergy’s gross sales. The tax issues involved are somewhat complex but understandable.
The state tax audit of the manufacturer in Brattleboro involved a dispute over the Vermont use tax (an offshoot of the sales tax) on fuel purchased out of state to generate energy used during the manufacturing process. Normally, the use tax is not levied on components in the production cycle because the sales tax is collected when the finished product is sold. Taxing the manufacturing components is tantamount to double taxation when the use tax is added-in to the finished product sales tax.
During the audit, the Vt. Dept. of Taxes unilaterally decided that the use tax must be collected on all the components in the manufacturing process, including the source of energy, because the finished product was completed and sold outside of Vermont.
The existing state tax law on this issue is very ambiguous and could easily be interpreted two different ways. The Vt. Dept of Taxes insisted that their interpretation was correct costing the Brattleboro manufacturer about $25,000 in non-deductible use taxes and penalties.
The manufacturer was highly motivated to contest the tax department’s decision in court but rejected the idea because of the litigation costs. It appeared to be a no win predicament for the manufacturer.
At this point in the story, Mr. Leonard, the response to the tax audit by the manufacturer was incredibly audacious and absolutely blindsided the tax department. Instead of challenging the state’s decision, the company requested a private tax ruling from the Internal Revenue Service. The argument presented to the IRS was very unique.
The equipment used in the mechanized process was so integrated into the design and function of the buildings that the building’s structural components would physically adjust to maximize the efficiency of the manufacturing process. Because the buildings and equipment were so inter-dependent upon each other, if the manufacturing machinery was sold off and removed, then the buildings would be unusable for any other purpose and have no value. Therefore, for tax purposes, the buildings should be reclassified as equipment.
The IRS ruled in the manufacturer’s favor. The Vermont Tax Department was horrified.
Why?
Because depreciation is non-cash expense that reduces the corporate income tax to offset the replacement costs of the physical assets that wear out over time. Buildings are normally depreciated (written off) over nineteen years. Most manufacturing equipment can be fully depreciated between five and seven years and under special circumstances in one year to encourage re-investment in new equipment and job expansion.
The immediate impact of the IRS ruling reduced the manufacturer’s state corporate income tax liability from $44,000 a year to $0.00. Amended returns were then filed for the previous three years resulting in a refund of all previously remitted corporate income taxes plus interest.
It was then that the manufacturer dropped another financial bomb on the tax department. Because the buildings were reclassified as equipment, the sales tax collected on the construction materials used to fabricate and maintain the buildings (reclassified as equipment) should be refunded in full with back interest because state tax law specifically excludes the collection of the sales tax on manufacturing equipment.
Over a six year timeframe, the $25,000 use tax liability paid by the Brattleboro manufacturer ended up costing the State of Vermont approximately $400,000 in refund checks and lost tax revenue from just one company. The Vt. Dept. of Taxes insisted that the audit remain secret for fear of tipping off other business in Vermont about the IRS ruling that had precedence over Vermont tax law.
So how does this true story relate to Entergy’s current predicament with the Vermont Legislature?
Well, one of the fun things to do in life is to pretend that you are a CEO of a major corporation and ask yourself how you would respond to a major crisis. If I was fortunate enough to be the CEO of Entergy, I would initiate the following course of action before July 11th.
(1) Assemble your best and brightest tax specialists and break out into detail every type and amount of tax that Entergy remits to the State of Vermont. Please re-read the ninth paragraph of this letter and think about using the IRS to challenge the federal tax depreciation laws that could substantially reduce your Vermont corporate income tax liability.
(2) Entergy pays millions of dollars a year in use taxes when the spent uranium from Vernon is shipped to France to be re-enriched (don’t ask me how I know this) and then shipped back into Vermont. This use tax may very well constitute double taxation if the Legislature is going to tax your gross receipts based upon the electricity generated (i.e. the finished product). Challenge the manufacturing use tax laws in Vermont.
(3) Before July 11th, issue the following press release. “Entergy Corporation believes the gross receipts tax is unfair. However, if the Legislature overrides the Governor’s veto then Entergy Corporation will not object because the long term commitment to climate change is also a commitment by the Legislature to extend Entergy’s operating license beyond 2012.”
In other words, Mr. Leonard, link the climate change vote to Entergy’s operating license renewal. It’s a strategy that will drive the Entergy haters in the legislature totally bonkers. If they scream that the two issues are not related, than take out full page ads in every Vermont newspaper explaining that the two issues are related and be sure to thank Senator Peter Shumlin for committing the Legislature into supporting the extension of Entergy’s operating license beyond 2012.
Mr. Leonard, I am going to relate to you a secret about doing business in Vermont. Because Vermont is such a high tax burden state, companies generate additional profit not by increasing their sales but by finding ways to reduce their tax liability.
If the Vermont Legislature overrides Governor Douglas’ veto of the climate change bill, then find a way to decrease your other Vermont taxes by thirteen million dollars a year – your cost of the climate change law.
This strategy is called “Net Sum Zero”. Just because a new tax is created in Vermont, does not mean that tax will generate (pun intended) more revenue. As a matter of fact, oftentimes a new tax ends up costing the state additional revenue because those paying the tax will find a way to offset it that will not reduce their net operating profit.
Similar to the manufacturer in Brattleboro twenty-five years ago, work all of the tax laws to Entergy’s financial advantage. From a purely political perspective, linking the climate change bill to Entergy’s license renewal will back Senator Shumlin into a political corner. Believe me, Mr. Leonard, when that happens Mr. Shumlin will fold like an accordion.
The best way to deal with your vocal opponents in Montpelier is to deprive them of what they want most – Entergy’s tax revenue. The way to do that is to pretend in public that Entergy supports the Climate Change law and then quietly implement a tax saving strategy that sticks it up the Legislature’s behind.
That’s the real satisfaction of doing business in Vermont.
Very Truly Yours,
RLElkins
PS. If this strategy works, the anti-nuke protesters in town will object by running around the Harmony Parking lot and along Elliot Street naked. That's the level of mentality you are dealing with here in Brattleboro.