Puerto Rico gov’t proposals for federal tax reform stress island isn’t foreign
SAN JUAN – The government of Puerto Rico has submitted its list of proposed amendments to federal tax reform to stop Congress from what it believes would destroy the island’s manufacturing sector and be the demise of Puerto Rico’s already shattered economy.
“Puerto Rico’s economic recovery depends on the continued ability to attract and sustain manufacturing, which accounts for nearly half of Puerto Rico’s GDP [gross domestic product] and employs nearly 75,000 people in good paying jobs. Indirect employment is an additional 160,000 jobs,” the government reminded Congress in the proposed amendments, adding that Puerto Rico supports 80,000 U.S. mainland jobs.
In a majority vote, the House Ways and Means Committee approved a tax plan proposed by Republicans that would establish a 20% tax on products manufactured outside the United States, a move that would seriously hurt the island. For U.S. Internal Revenue Code purposes, Puerto Rico is a foreign jurisdiction, so the proposed tax will repeal incentives for companies to start operations locally.
The measure, which is expected to be approved next week by the full House, also proposes reducing the corporate tax rate from 35% to 20% and granting a preferential rate of up to 14% for multinationals to repatriate foreign profits. The Senate also presented Thursday a summary of its version of tax reform, which would also be detrimental to the island, as it proposes a global minimum tax of 12.5% on overseas earnings that would also impact goods from Puerto Rico.
The reform proposals do not exempt the U.S. commonwealth from the tax on imports, which would be harmful to manufacturing, a sector that is more than 46% of the island’s gross domestic product. Pharmaceutical and medical device manufacturing alone comprise nearly 75% of Puerto Rico’s exports, or $14.5 billion in 2016.
The government said that if Congress moves ahead with a Repatriation Toll Charge or one-time tax on profits earned overseas, companies in Puerto Rico should be exempt from the provision subject to a two-part “nexus test.”
The first part is that the company eligible for the exemption must continue to operate in Puerto Rico within the eight-year period required for payment of the federal repatriation tax. As a second condition, companies–as defined as those existing when Promesa was enacted or new ones–will be required to keep no less than 50% of the their exempted earnings and profits on the island.
“Because Puerto Rico is a territory of the United States, it should not be put on par with non-U.S. jurisdictions for purposes of the toll charge. Rather, to the extent that reinvestment in the Puerto Rico economy can be encouraged, [earnings and profits] earned through manufacturing operations in Puerto Rico as of the testing date for the toll charge should be exempt from the toll charge,” the proposal reads. Earnings and profits taken out of the island will be subject to the tax.
The local government is also seeking to be exempt from a proposed tax on goods produced in foreign countries. “The goods manufactured in Puerto Rico have, for many years, predominantly been for consumption in the United States,” the proposal adds.
Assuming Congress imposes a corporate tax on goods produced by controlled foreign corporations (CFCs) in Puerto Rico for sale on the U.S. market, the government says the U.S. parent company of the Puerto Rico CFC should be allowed to exclude from the tax 50% of profits from sales in the U.S. market.
The island’s government said that to encourage the competitiveness of Puerto Rico, as compared to non-U.S. jurisdictions, Congress should enact one of two options in the event of an application of a 15% minimum tax rate on foreign earnings and profits going forward.
The first option calls for a full tax exemption of earnings made in Puerto Rico and the second option calls for a 10% not a 15% tax on those earnings.
Mounting job loss
The government reminded Congress of the dire consequences to the local economy of ignoring Puerto Rico’s pleas for better treatment in the proposed tax reform. In 1996, Congress repealed Section 936 tax incentives for U.S. companies on the island, and has “ignored” government requests to extend a limited incentive in the form of a Section 30A wage credit to ensure job growth in manufacturing.
“Since then, we have seen how these tax-based economic decisions have had far-reaching and negative consequences for Puerto Rico, given that the number of direct manufacturing jobs in Puerto Rico has fallen from 155,000 in 1997 to the present level of about 75,000. Thousands of Americans in Puerto Rico lost good manufacturing jobs, due in large part to federal tax policy decisions, having subsequent and obvious negative effects that have reverberated to other areas of the island’s economy,” the government’s document reads.
While Congress has enacted tax provisions to promote Puerto Rico’s international competitiveness as a manufacturing destination, including a decision to treat manufacturing companies operating in Puerto Rico as CFCs, the government reminded lawmakers that Puerto Rico does not compete with the mainland, but with low-tax, less-regulated, lower-cost foreign jurisdictions.