WASHINGTON – Some municipalities in the Midwest have been forced to return millions of dollars in property tax payments to big box retailers who challenged their assessments using an argument called the “dark store theory.”

S&P Global Ratings issued a report Tuesday alerting municipal market investors that an expected increase in these property tax challenges could put stress on municipal finances.

Home Depot storein Torrance, Calif.
Home Depot storein Torrance, Calif. Bloomberg News

Under the dark store theory, a big box retailer that is in operation, but believes its tax assessment is too high, argues that it should be assessed like a comparable store that is dark or vacant.

The S&P report said that retail chains such as Lowe’s, Home Depot, Sam’s Club, Wal-Mart, Target and Kohl’s have begun using this “controversial legal tactic” to reduce their property tax bills.

“In states such as Michigan and Indiana, this argument has largely withstood judicial scrutiny, leading to hundreds of store devaluations and to hundreds of millions of dollars in estimated lost tax revenue to local governments,” said the report, which was authored by credit analysts Scott Nees and Geoffrey Buswick.

“It’s sort of an emerging risk type issue,” Nees said in an interview. “It’s not one that we are seeing all across the country right now but we are seeing it in a few pockets. We do think it could have an actual substantial credit impact if it were to hit the right type of issuer at the right time.”

Nees and Buswick said they have been seeing the growing use of these property tax challenges over the last couple of years.

One Indiana case involving the Town of Merrillville resulted in a $2.3 million award to Meijer supercenters for taxes paid in prior years plus interest. Merrillville also faces 21 additional property tax appeals from big box retailers “which could have significant and lasting effect on its fiscal health and ability to continue funding services at current levels,” Nees and Buswick wrote in the report.

Several states – including Wisconsin, Michigan and Indiana – have tried to address the issue legislatively.

In the Wisconsin Legislature, Senate Bill 292 would require assessors to use the sale or rental of similar properties with the highest and best use.

The bill also defines a building as “dark property” only if it is vacant or unoccupied beyond the normal period for property in the same real estate market.

Although retailers have won cases in Michigan, the Michigan Supreme Court n in October 2017 rejected the dark store method of assessing property taxes by denying an appeal by retail giant Menard Inc. and upholding a state Court of Appeals decision favoring the City of Escanaba.

These legal battles are coming as the same time that states and local governments across the country are awaiting a decision by the U.S. Supreme Court on efforts by local and state governments to collect sales taxes from online retailers.

The high court recently announced it will hear arguments in South Dakota v. Wayfair. The court had been widely expected to take the case, viewing it as an opportunity to revisit its 1992 ruling in Quill Corp. v. North Dakota.

The Quill ruling limited states and localities to collecting sales taxes from retailers with a physical presence in their jurisdictions.

The inability of states and localities to collect sales tax from fast growing online retailers already has put stress on both big box retailers and municipal governments.

“It all kind of comes together,” Buswick said. “The brick-and-mortar retailers are trying to compete with online to keep their costs as low as possible.”

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