Uncertainty Clouds One-Fourth of Puerto Rico’s Revenues
SAN JUAN — Roughly $2 billion of Puerto Rico’s annual tax revenue hinges on a U.S. Treasury Department’s provisional notice that effectively allows for its existence. It is still uncertain whether these funds would be available after 2017.
Act 154 of 2010 calls for a 4% excise tax on multinational manufacturers operating on the island. Initially intended to scale down annually until its phase out in 2013, Gov. Alejandro García Padilla quickly extended its duration until 2017, this time under a fixed 4% rate.
Under the most recent long-term fiscal plan, the administration is calling for a five-year extension to the 4% excise tax, along with the go-ahead of the Internal Revenue Service (IRS) on its creditability against federal taxes. In return, officials vow to implement a new corporate tax system locally and eliminate Act 154.
“[Treasury] hasn’t said ‘yes’ or ‘no.’ They said, ‘show me what you are going to do with your tax structure.’ They said that if [the excise tax] is extended, it would need to be eliminated at some point, and there must be a substitute by that time,” recalled Government Development Bank (GDB) exiting President Melba Acosta, during a recent interview with Caribbean Business.
In 2011, the IRS issued a temporary authorization on Act 154’s creditability, but has yet to enter a permanent ruling on the matter. Act 154 companies pay the Puerto Rico government, and then claim a federal tax credit against the levy.
“My first meetings with [U.S. Treasury] were to discuss whether they could issue a ruling instead of the notice that we have now. At first, I saw much resistance,” Acosta said.
The federal government would be reluctant to allow Act 154, an excise tax, to continue to be credited against U.S. income taxes. “They said this is not typical,” she indicated.
As part of Capitol Hill’s debate on Promesa, flags were raised over Treasury’s treatment of the tax, as some view it as a bailout in disguise for the island. In February, a spokesperson for Treasury told Reuters it continues to evaluate the federal tax credit’s legality, but stressed that any decision would apply prospectively.
In its most recent audited financial statements, the Puerto Rico government acknowledges concerns over the continuity and “significant dependency” on Act 154 revenues, which are paid only by a handful of companies, mostly pharmaceuticals. Even with a favorable ruling from Treasury, the credit could still be subject to challenge in court.
During the first 11 months of fiscal 2016, the government received $1.67 billion from Act 154, $24 million less than revised estimates and $65 million less than the same period in fiscal 2015.
For Acosta, the potential loss of these monies could land a mortal blow to the Puerto Rico government’s coffers. The 4% excise tax constitutes almost a fourth of the island’s annual revenues—which are estimated at roughly $9 billion for this fiscal year.
Since its inception in 2010 by former Gov. Luis Fortuño, the idea was to have the excise tax transition into an income tax, through what is known in accounting jargon as “modified source income rule.”
According to Acosta, García Padilla’s fiscal team presented a simpler modified source rule to Treasury, worked by tax lawyers in D.C. “We couldn’t convince [Treasury],” she said.
For the exiting GDB chief, the only option is to revisit what these companies pay in income taxes under tax decrees and royalties—the other two main sources of corporate taxes in Puerto Rico. “We talked with companies about this, and they were ok with it. For them, it is important that those taxes are creditable,” she said.
A BIGGER PICTURE
In the run-up to Promesa’s passage, Acosta acknowledged there were efforts on Capitol Hill to change federal taxation rules for the commonwealth. As reported by this newspaper, a deduction for dividends received under a Section 243-A of the Internal Revenue Code was one idea that was discussed, but was never introduced into the bill’s final language.
“You need to look at the bigger picture of what is happening with respect to the U.S. tax system,” she noted, pointing at recent efforts by Congress to change international tax rules. While she was P.R. Treasury secretary in 2013, she remembered a conversation with Warren Payne, who was an adviser to former Rep. Dave Camp (R-Mich.), an advocate of tax reform.
“I told them that [Camp’s tax reform], which sought to tax all money coming back from foreign jurisdictions I think at 15%, a reduced tax, sounded good in principle. But Puerto Rico’s problem is that it is foreign for U.S. tax purposes,” recalled Acosta, noting how the island was to be subject to the same rate as any other foreign jurisdiction.
“It is a disadvantage,” she continued. “I remember Payne’s response at the time was, ‘We get it, but we haven’t considered the effect on Puerto Rico. In the past years, nobody from Puerto Rico has come to discuss matters of international taxation—only status.’”
According to Acosta, officials and tax lawyers met with some multinational companies operating on the island, and developed several tax-treatment ideas for Puerto Rico, as a U.S. territory, that were presented back in D.C. “They didn’t buy it. Camp left, but the idea [to overhaul the federal tax system] is still out there,” Acosta warned.
Payne, who works at the law firm of Mayer Brown in D.C., is now a lobbyist used by the P.R. Industrial Development Co. (Pridco) as part of efforts to push for Section 243-A. The agency has paid the firm $140,000 since 2015, according to lobbying disclosure reports.
Also brought to the table was adopting a territorial approach, vis-à-vis the U.S.’ worldwide income rule, whereby all must be reported, no matter where it is generated.
“In Puerto Rico, this whole CFC [controlled foreign corporation] framework is based on the worldwide [income rule]. The companies pay taxes everywhere, but they take credits from what is paid here. That includes Act 154,” she said.
“If you eliminate this scheme, as it has been suggested, we have to go back to the drawing board,” Acosta went on to say. For her, this is one aspect that Promesa’s fiscal control board must look into.
“Maybe [Congress] thought they needed more analysis; what will ultimately be Puerto Rico’s tax system? 243-A? 933-A? Maybe that is why they put up this task force to give thought to this,” she continued.
Acosta refers to the federal law’s Congressional Task Force on Economic Growth in Puerto Rico—an eight-member bipartisan committee comprising members from both chambers. The group will brief Congress within the first 15 days of September, and present a report by Dec. 31 with its findings.