Water's Edge Election: It is Time to Eliminate this Corporate Tax Break

Jan 18, 2017

By MBPC Staff

On Thursday, the Senate Taxation Committee will hear Senate Bill 105, repealing the water's edge election for corporate income tax purposes. The water’s edge election represents a multi-million dollar giveaway to large multinational corporations operating in Montana, and SB 105 aims to level the playing field for Main Street businesses across the state while also ensuring we have adequate revenue here in Montana to invest in our communities.

What is the water’s edge election, and why should we eliminate this corporate tax break?

First we need a refresher on combined reporting, which is the way Montana taxes corporations. Many large companies consist of a parent company and its subsidiaries. Combined reporting requires a parent company to add its income and its subsidiaries’ incomes for the purposes of state corporate income taxes. Montana then taxes its share of the total income based on the level of activity in Montana as a percent of the company’s total activity. States without combined reporting are vulnerable to a wide array of tax avoidance strategies by corporations which usually involve artificially shifting profits to subsidiaries that are in states without corporate income taxes or that do not tax a specific type of subsidiary.

Combined reporting ensures that corporations pay their fair share of taxes in Montana based on their corporate activity in Montana. In addition, it levels the playing field for smaller Montana-based companies that do not have subsidiaries across the country to which they can shift profits.

Montana requires worldwide combined reporting, which means that corporations with common ownership must report all income worldwide basis. Montana provides an exception to this rule, called the water’s edge election, which allows multinational corporations to only report their income within the borders of the United States, rather than their worldwide income. In exchange, these companies agree to pay a 7% tax rate, rather than the normal rate of 6.75%. The number of corporations that filed a water’s edge election in Montana increased 226% from 2007 to 2012.

There are some limits to the water’s edge exclusion. If a subsidiary is located in a country that is a known tax haven, the corporation may not exclude that subsidiary’s income even under the water’s edge election. In order for this exception to be useful and avoid inappropriate income shifting, the list of tax havens must be updated regularly in Montana law. Unfortunately, the Montana legislature has failed to update the list of tax havens in past sessions.

A cleaner way to address the inequities and level the playing field for Montana small businesses would be to eliminate the water’s edge election entirely. The Governor has called for the elimination of the water’s edge election in his budget, and the Senate Taxation Committee will hear Senate Bill 105 to do just that. The bill will eliminate the ability of multinational corporations to shift profits overseas without paying state corporate taxes reflecting actual operations in the state. We need out-of-state corporations to pay their fair share for the schools, roads, and bridges they rely upon for the success of their business.

MBPC recently wrote a report on how Montana taxes corporations. You can read that full report Policy Basics: Montana Corporate Income Taxes.