U.S. Senate Finance Committee Chairman Charles Grassley (R-IA) said Thursday that he hoped to win full Senate approval next week of a bill that would affect the decisions companies in the States make about locating manufacturing operations in Puerto Rico.
The bill’s purpose is to reform tax laws regarding business that U.S. companies conduct abroad. It would, however, provide contradictory tax incentives regarding manufacturing in the case of Puerto Rico.
A potent incentive would encourage companies already in Puerto Rico to take money away from the territory and relocate it in the States. A lesser incentive would encourage the companies to keep plants in Puerto Rico and encourage new investments.
Part of the reason for the negative provision and for the contradiction between the incentives is the tax status of the territory and inconsistencies between its tax and trade law status. The other part of the reason is that Puerto Rico’s Resident Commissioner, Anibal Acevedo Vila ("commonwealth" party/D), sought the incentive to encourage companies to take funds away from the territory.
The bill would provide companies in the States with a one-year window of a very low income tax rate on funds they take from their ‘controlled foreign corporations’ (CFCs). The 35% corporate income tax rate would be cut to 5.25% for the year in the case of ‘repatriated’ funds. The 35% rate would return after the year is up.
Experts believe that the one-year minimal tax rate would be a powerful incentive for companies to repatriate funds during the year. They have calculated that companies would bring hundreds of billions of dollars now in CFCs to the States for reinvestment.
Companies can set up CFCs in U.S. territories as well as in foreign countries under federal tax law even though the location of CFCs in U.S. territories was not the law’s purpose. Most manufacturers based in the States with operations in Puerto Rico have converted the operations from being domestic companies to CFC status in recent years.
They did so to take advantage of the tax advantage that CFCs offer after the federal government began the phase-out of more lucrative incentives for manufacturing in Puerto Rico that expire at the end of next year. Corporate profits from CFCs are not taxed until the profits are repatriated, although the profits are then taxed at the normal corporate income tax rate.
The conversions avoided federal intent regarding the taxation of profits from territorial operations. The paper maneuvers enabled companies to indefinitely defer income taxation that partially applies now and that the federal government intended fully apply as of 2006.
Despite this, the Senate Finance Committee did not intend for the one-year tax cut to provide an incentive for companies to withdraw funds from Puerto Rico. That was Acevedo Vila’s idea.
When the Committee was acting on the CFC disinvestment proposal, Acevedo asked that it be applied to Puerto Rico as well as to foreign countries. The Committee voted to do so at his request -- a fact that he actually boasted about.
The resident commissioner appeared to not understand what the proposal was intended to -- and would — do, although it had been widely discussed in Congress. He also seemed to think that the proposal was a step towards his primary goal: permanently cutting the federal income tax rate on manufacturing profits from Puerto Rico to 0-5.25%.
There were 180-degree differences between the proposal and his goal, however. The proposal is only intended to be in effect for a short time-period. Its purpose is to provide companies with an incentive to take funds away from CFCs. (A long time-period would provide an incentive to keep funds out of the States.) Acevedo wanted a permanent tax cut.
Puerto Rico’s representative in the Congress presumably wants an incentive for investment in Puerto Rico -- not disinvestment -- but that is not what Acevedo asked for.
After Acevedo’s mistake became clear, he stubbornly refused to admit it, however. To the contrary, he tried to suggest that the one-year tax cut would be of economic benefit to Puerto Rico, although he never explained how it could be. He also did not ask to have his mistake corrected when the Finance Committee’s leaders offered to do so.
Acevedo -- again acting amazingly contrary to Puerto Rico’s economic interest -- complained when the committee amended the bill to extend the other tax provision -- the one that would be beneficial to Puerto Rico -- to the territory.
The provision would cut the income tax rate on profits from domestic manufacturing from 35% to 32%. Since many federal tax laws have not been extended to Puerto Rico, the provision originally did not include Puerto Rico as a domestic area, although it is domestic for trade law purposes and some taxes apply as if Puerto Rico were a State.
The effect of the provision as it was introduced is that it would have cut the tax on manufacturing income from the States to 32% while allowing the tax rate on manufacturing income from Puerto Rico to rise to 35% in 2006.
The purpose of the domestic manufacturing tax cut was the same as the CFC disinvestment provision: encouraging manufacturing in the States rather than in foreign countries.
Senator John Kerry (D-MA) -- the now likely Democratic candidate for president of the United States -- proposed including Puerto Rico in the definition of domestic areas. This would provide companies with a greater incentive to manufacture in the territory than in foreign countries, where costs of doing business are generally less.
The committee agreed with Kerry but Acevedo complained. "That’s not what we want," he fumed.
What he wanted was the proposal to cut the tax on profits from Puerto Rico to 0-5.25% on a permanent basis. The committee overwhelmingly rejected that proposal when it was offered as an amendment to the bill. Senators said that it would be unfair to the States to have a much lower tax rate on manufacturing income from Puerto Rico than on manufacturing income from the States.
Acevedo preferred a nine percent higher tax rate on manufacturing income from Puerto Rico (35%) than on manufacturing in the States (32%).
The Democratic Governors Association last Saturday took the unusual step of endorsing one Democrat over another in a gubernatorial race. The nation’s Democratic governors backed the candidacy of former Puerto Rico Governor Pedro Rossello (statehood) over that of Resident Commissioner Anibal Acevedo Vila ("commonwealth").
Democratic credentials were a key factor in the decision: Rossello has been an active national Democrat. Acevedo has not even been a reliable Democrat.
Acevedo, who hopes to be elected a Democratic governor this year, shocked national Democrats during gubernatorial campaigns in States two years ago. First, he gave tacit support to Republican George Pataki in New York by saying that Pataki would be as good for Puerto Ricans as the Democratic candidate -- who was strongly supported by most leaders of Puerto Rican origin in the State.
Then, he declined to support the Democratic candidate in Florida against Republican -- and presidential brother -- Jeb Bush.
New York Democratic leaders were so upset with Acevedo and his 2000 running mate, Governor Sila Calderon -- who actively campaigned for Pataki -- that they asked Rossello to come to the State to campaign too. When he did, they proclaimed that the former governor was still the governor of Puerto Rico as far as they were concerned.
It might seem that Rossello had an advantage in obtaining support from the nation’s Democratic governors because he is a former Democratic governor. Almost all of the Democratic governors, however, took office after Rossello left office and did not have a personal relationship with him. They undoubtedly learned, though, that Rossello was a very highly regarded Chairman of the Democratic Governors Association in addition to learning of Acevedo’s ‘Democrat of convenience’ credentials.
Acevedo’s Democratic offenses include lavishing undue praise on President Bush and ignoring the achievements of Bush’s Democratic predecessor, Bill Clinton. A spectacular example of this is that Acevedo credits Bush with ending military training at the former U.S. Navy range on the island of Vieques, Puerto Rico. In fact, the end last May 1st was set by Clinton in a formal agreement with Rossello in 2000 and the Bush White House decided to leave the issue to the Navy.
For Democrats, Acevedo also has questionable Republican alliances. His closest ally in the U.S. Senate is Trent Lott. One of his closest allies in the House of Representatives is Roger Wicker, another conservative Republican from Mississippi.
