PUERTO RICO REPORT: 243 Is The New 956. . .And 936

243 is the new 956 . . . and 936

Puerto Rico representatives struggled in discussing a new federal tax agenda with reporters in Washington this past week.

Cutting through the rhetoric and complex terms, the new agenda sounds a lot like old and discredited agendas of tax exemptions for profits that companies in the States attribute to manufacturing in the territory.

The new agenda began to be revealed at a Puerto Rico Manufacturers Association convention in the territory last weekend. It was brought to light there by Governor Anibal Acevedo Vila ("commonwealth" party/D) and the territory’s resident commissioner in the States, Luis Fortuno (statehood/R).

Acevedo endorsed proposals he ascribed to the Association. Fortuno more carefully said that he would ask the staff of the Congress’ Joint Committee on Taxation to estimate costs of and otherwise advise on key elements of the package -- although he also suggested that he was open the measures.

Later in the week, Fortuno distanced himself from major proposals after Secretary of Economic Development and Commerce Jorge Silva Puras and Manufacturers Association officials discussed the package.

The main initiative would exempt from taxation earnings that a company in the States receive from a company organized in a U.S. "possession" (that is, a U.S. territory like Puerto Rico) that primarily does business in the territory.

The proposal would amend Section 243 of the Internal Revenue Code (IRC) but it would have a very different effect than Sec. 243 -- one that would not be consistent with the purpose of Sec. 243.

Sec. 243 provides that a domestic -- that is, taxed -- company in the States can deduct from its taxable income most dividends it receives from another domestic company that is at least 80% owned by the same owners. The purpose is to prevent double taxation of the income of separate corporate entities that are really just different parts of the same business. The income would be taxed in the case of the paying company.

The law also provides that up to 80% of the dividends a company receives from a company 20-80% commonly-owned can be deducted from taxed income, and as much as 70% of dividends can be deducted in the case of companies that have less than 20% common ownership (including no common ownership). With the corporate income tax rate of 35%, deducting 80% of dividends from taxable income produces a tax rate of seven percent and deducting 70% of dividends produces a rate of 10.5% The purpose of these provisions is the same as in the case of companies more than 80% owned by the same owners: to prevent double taxation.

The Puerto Rico amendment would enable a domestic company to deduct dividends received from an untaxed Puerto Rico corporation from the company’s taxable income. Its effect would be that Puerto Rico earnings of companies that have 80% the same owners would never be taxed -- vs. the Sec. 243 purpose of preventing double taxation.

Puerto Rico earnings of companies 20-80% commonly-owned would be taxed at a rate of seven percent -- vs. 35% -- and Puerto Rico earnings of companies less than 20% commonly-owned would be taxed at a rate of 10.5% vs. 35%.

Eighty percent of the Puerto Rico corporation’s income would have to come from doing business in Puerto Rico and the deduction could not be greater than half of the domestic company’s taxable income less the total amount of dividends it received from other corporate entities -- but these are conditions many companies could meet.

Manufacturers Association officials said that the intent of the proposal was to help "small and medium-sized" businesses and not "multinationals" but the tax exemption could be -- and probably would be -- used by any-sized business.

Economic Development and Commerce Secretary Silva said that the proposal would be amended if needed so that it would not cost the U.S. Treasury more than $1 billion a year in forgone taxes on the understanding that $1 billion a year was the maximum that congressional tax writers would accept. But Resident Commissioner Fortuno later questioned whether a cost of even that much was realistic to get approved.

The proposal bears a striking resemblance to the IRC Sec. 956 amendment that Acevedo as resident commissioner, predecessor as governor Sila Calderon, and drug companies unsuccessfully lobbied for between 2001 and 2004.

That amendment would have exempted from taxation 85, 90, or 100% of dividends that a taxed domestic company received from a "Controlled Foreign Corporation" (CFC) in Puerto Rico, producing tax rates of 5.25%, 3.5% or 0% vs. the normal 35% rate. A CFC is a subsidiary of a domestic company organized in a foreign country or a U.S. possession. CFC income is taxed at the 35% rate when received by the parent company in the States.

Tens of millions of dollars were spent on the failed 956 amendment campaign but the proposal was consistently rejected by federal tax authorities from the time of its first presentations in Washington.

A primary reason for its rejection was the same primary reason that the federal government in 1996 decided to phase out a tax incentive enacted in 1976 to encourage job-creating investments in Puerto Rico: Much lower tax rates for income from manufacturing in Puerto Rico are unfair to the States and companies manufacturing in them.

The reason was the main one cited for rejecting the Sec. 956 amendment in the Senate Finance Committee’s debate over the amendment last year. It was also the main one cited in the Committee’s report on the 1996 legislation that phased out the incentive created in 1976.

That incentive, provided by Section 936 of the IRC, gives companies a credit against the taxes due on income attributed to manufacturing in Puerto Rico.

The credit against 40% of the taxes was reduced from 100% in 1993. The reason for the 1993 reduction was that companies abused the credit by attributing to Puerto Rico income that was really due to work in the States -- where income from the work would be taxed.

The credit based on attributed income resulted in companies getting much more benefit from the credit than Puerto Rico did.

The 1996 law limited the credit to companies that were already taking advantage of it and ended the credit for those companies at the end of this year.

Extending the 936 credit for one more year is another element of the tax package now being sought.

The package would also extend for another year a tax credit that the federal government created in 1993 as a preferred alternative to the 936 credit. IRC Sec. 30A provides a credit against federal taxes for wages and local taxes paid in Puerto Rico and capital investments made there.

Calderon and Acevedo opposed offers by leading members of Congress to try to have Sec. 30A extended while they were lobbying for the ill-fated 956 amendment.

Another proposal in the package would include income from manufacturing in a U.S. possession in a nine percent tax cut for domestic manufacturing enacted into law last year. The U.S. Senate approved inclusion of Puerto Rico and the other possessions in the tax cut through an amendment sponsored by Senator John Kerry (D-MA). But the amendment was dropped from the legislation in a Senate-House of Representatives conference after Acevedo complained "That’s not what we want" in lobbying for the 956 amendment instead.

Pressed by the Coca-Cola Company, Acevedo sought inclusion of income from manufacturing in Puerto Rico in the nine percent tax cut in the last hours of the conference -- when it was too late.

Fortuno has revived the proposal and Acevedo is now supporting it as another element of the tax package.

A final element of the package would enable CFCs in Puerto Rico to take advantage of the credit against taxes due for research and experimentation costs. The credit can now be taken by companies that use the Secs. 936 and 30A credits.

PUERTO RICO HERALD - WASHINGTON UPDATE

243 Is The New 956. . .And 936