New U.S. Treasury regulations would not affect Act 154 creditability
P.R. Treasury chief: Feds still working on transition for phaseout of CFC excise tax credit
Puerto Rico Treasury Secretary Francisco Parés Alicea said that the U.S. Department of Treasury official in charge of tax policy assured him on Friday that a regulation the agency issued last month concerning controlled foreign corporations, or CFCs, does not alter the federal creditability of the commonwealth’s decade-old 4 percent excise tax on CFC earnings under Act 154.
Parés Alicea said that in a telephone meeting on Friday with David J. Kautter, the U.S. Department of the Treasury’s Assistant Secretary for Tax Policy, the federal official told him that the provisions of the proposed regulation that would alter the scope of the creditability of taxes paid overseas by U.S. companies do not apply to Puerto Rico.
“Secretary Kautter confirmed that the intention of the proposed regulation is not to affect the regime under Act 154, but that [rather] it is aimed at certain taxes on digital services that are being levied in other foreign countries,” the commonwealth Treasury secretary said in a press release, in which he stressed that the U.S. Treasury official told him that the excise tax credit was still in force and that the agency was still working on unspecified “transition measures” to be implemented before the federal credit is phased out.
Parés Alicea said that Kautter, who is in charge of managing the Internal Revenue Code (IRS) and establishing U.S. tax policy, clarified during the meeting that the regulation is at an initial stage and that it will take more time before a final version is adopted.
The Treasury chief said that Kautter told him that “the determinations that the U.S. Treasury has made in relation to the accreditation of contributions paid under the excise tax established by Act 154 of 2010 remain in force.”
“I am optimistic about the statements aired by Secretary Kautter, in which he pledged to continue collaborating with the Government of Puerto Rico to provide transitory measures that allow orderly emigration towards an income tax system for these taxpayers, without adversely affecting the island’s economy,” Parés Alicea said in the press release issued Friday night. “This openness by one of the highest-ranking officials of the [U.S.] Treasury is a source of great satisfaction and we will make sure that this direct communication is maintained, so that we can ensure that our observations and recommendations are taken into account and are accepted.”
The commonwealth Treasury chief explained that a team of tax experts from both his agency and the U.S. Treasury has been created to handle together “any suggestions and concerns” involving matters such as Act 154 and will play an “active role in the process of evaluation.”
“This commitment began today [Friday], after holding a productive meeting on technical aspects of the proposed regulation,” Parés Alicea said. “The support of AAFAF [Fiscal Agency & Financial Advisory Authority] and its executive director, Omar Marrero, and the secretary of the Department of Economic Development, Manuel Laboy, has been essential to maintain an effective communication channel in this process both with the Federal Treasury and with the manufacturing sector.”
For her part, Gov. Vázquez said in the press release issued by the commonwealth Treasury Department that she was “very pleased with the response and encouragement from Secretary Kautter to address our concerns.”
“This action by the Administrator proves once again that our administration managed to regain the trust of the federal government,” she said. “We will remain attentive and diligent to provide all the necessary information to achieve forceful actions for the benefit of Puerto Rico.”
Parés Alicea had issued a statement Wednesday evening in which he said he was requesting an explanation from U.S. Treasury officials on the possible impact on the Puerto Rico economy of provisions contained in a recently issued agency regulation, which he did not specify, that would affect CFCs on the island. A quick search by Caribbean Business revealed the latest IRS regulations in a document titled, “Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), Consolidated Groups, Hybrid Arrangements and Certain Payments under Section 951A.”
The regulation seeks to clarify changes made by the federal Tax Cuts and Jobs Act of 2017 to foreign tax credit rules.
A summary of the nearly 300-page regulation, approved by Kautter on Sept. 18, states that it contains “final regulations that provide guidance relating to the allocation and apportionment of deductions and creditable foreign taxes, the definition of financial services income, foreign tax redeterminations, availability of foreign tax credits under the transition tax, the application of the foreign tax credit limitation to consolidated groups, adjustments to hybrid deduction accounts to take into account certain inclusions in income by a United States shareholder, conduit financing arrangements involving hybrid instruments, and the treatment of certain payments under the global intangible low-taxed income provisions.”
The document states that the regulation was “submitted to the Office of the Federal Register (OFR) for publication and will be pending placement on public display at the OFR and publication in the Federal Register.” The effective date of the regulation is 60 days after it has been published in the Federal Register.
Feds warn of end to tax credit
During the last few years, U.S. Treasury officials have alerted commonwealth officials to prepare for the phaseout of the creditability of Act 154’s 4 percent excise tax on CFC earnings. The federal tax credit has been instrumental in getting stateside-based manufacturing corporations in Puerto Rico to buoy the island’s coffers through an excise tax.
The 4 percent excise tax has provided anywhere between a fifth and a quarter of the commonwealth’s general fund net income since it was instituted in 2010. Revenue from the tax totaled $1.85 billion in fiscal year 2020, which ended June 30, or nearly 20 percent of the $9.29 billion in general fund net revenue for the year, according to preliminary estimates issued by the commonwealth Treasury Department in August. About two dozen U.S. pharmaceutical and medical devices multinationals registered as CFCs on the island pay this tax.
Puerto Rico, a U.S. unincorporated territory, is considered a foreign location for federal tax purposes.
The Act 154 excise tax was first passed in October 2010 as a transitional measure to fund then-Gov. Luis Fortuño’s tax breaks to stimulate Puerto Rico’s economy while plugging budget holes amid austerity measures. In order to cushion the blow from the tax on the island’s manufacturing industry, the Fortuño administration managed to obtain a memorandum from the U.S. Internal Revenue Service allowing CFCs to claim a credit for the local excise tax on their federal income tax returns.
While the excise tax was originally intended to be scaled down annually to 1 percent in its fifth year before being completely phased out, the subsequent administrations of Alejandro García Padilla and Ricardo Rosselló signed legislation extending the term of the 4 percent tax to address the commonwealth’s deteriorating fiscal situation. As recently as September of last year, U.S. Treasury Steven Mnuchin told Gov. Vázquez and her economic team in a meeting in Washington, D.C. to prepare for the end of the federal creditability of the Act 154 excise tax, although he did not provide a timeline for its phaseout.
Economic Development Secretary Manuel Laboy told Caribbean Business just after this meeting that the elimination of the tax credit could cripple the island’s ability to retain its bioscience sector, which he noted constitutes 33 percent of the island’s gross domestic product and provides 18,000 direct jobs and 70,000 indirect jobs.