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Wal-Mart Civil Trial Challenging Transfer-Pricing Tax Gets Underway

By on February 5, 2016

Walmart

Wal-Mart Civil Trial Challenging Transfer-Pricing Tax Gets Underway

The civil trial in the lawsuit that Wal-Mart Puerto Rico filed against the commonwealth government over the hike in the transfer-pricing tax got underway this week at the federal court in San Juan amid concerns over the divulging of confidential government documents.

“You have to understand that this case cannot be treated in secrecy,” said Judge of the U.S. District Court for the District of Puerto Rico José A. Fusté, during a pretrial conference on Monday, contending his obligation is to maintain a balance. “The press will be here.”

The trial has 11 witnesses including Government Development Bank (GDB) President Melba Acosta and Treasury Secretary Juan Zaragoza, who will be called upon by Wal-Mart.

Fusté said he was going to try to protect the confidentiality of certain documents that the GDB did not want to be made public. The bank is currently in negotiations with creditors in an effort to restructure the island’s $70 billion public debt.

Despite limits on the ability of federal courts to interfere with tax collections, Wal-Mart sued the P.R. Treasury Department, contending that Act 72 of 2015 “unconstitutionally” singles out Wal-Mart for inequitable tax treatment.

Act 72 increases the rate at which tangible corporate property that comes from outside Puerto Rico is taxed, from 2% to 6.5% on entities doing more than $2.75 billion of business on the island.

The retail giant says the tax violates the Commerce Clause of the U.S. Constitution and equal protection laws. The Commerce Clause gives Congress the power “to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.”

Wal-Mart also alleges that the new tax rate will amount to more than 91% of its net income in Puerto Rico. Should the company’s net income fall, says Wal-Mart, the tax may actually exceed this figure.

For its part, the commonwealth government contends that the Butler Act prevents lawsuits that seek to restrain the collection of any tax imposed by the laws of Puerto Rico. In other words, the commonwealth’s position is the way to challenge a tax is to pay it first and then sue to get the money back.

The Butler Act, a close relative of the Tax Injunction Act, provides that “[n]o suit for the purpose of restraining the assessment or collection of any tax imposed by the laws of Puerto Rico shall be maintained in the U.S. District Court for the District of Puerto Rico,” according to an August 2013 decision regarding a case on Colorado’s efforts to collect sales tax by the U.S. Court of Appeals, 10th Circuit.

While legal experts contend Wal-Mart faces jurisprudence that places limits on the ability of federal courts to interfere with state taxes, this case is different because the multinational chain claims that the new law violates the Commerce Clause, as it is being taxed at 6.5% when it buys tangible property outside the commonwealth, but not if Wal-Mart buys the same property in Puerto Rico.

The lawsuit comes as Puerto Rico is amid a crippling debt crisis. The island’s efforts to address the situation have already resulted in a local bankruptcy law that would allow the territory’s utilities to restructure $20 billion in debt being thrown out in court. The U.S. Supreme Court is slated to hear an appeal on the case in March.

Puerto Rican and Obama administration officials have said the territory’s crisis is so severe it could turn into a humanitarian crisis if Puerto Rico can’t restructure its debt.

Meanwhile, Fusté dismissed earlier this month claims by the commonwealth government that Wal-Mart Puerto Rico had used transfer pricing to evade its proper tax burden as utterly irrelevant to whether those laws themselves are justified.

Revenue projections for Puerto Rico could be significantly affected by the transfer-pricing tax legal challenge filed by Wal-Mart.

Puerto Rico officials warned about the negative impact of the litigation as it updated projections for fiscal years 2016 to 2020 to account for year-to-date actual results. In response to creditor requests for additional information, projections were further extended until fiscal 2025.

“General fund inflow assumptions do not account for the potential risk of a material negative impact [$115 million in fiscal 2016] from the ongoing Wal-Mart litigation,” according to a footnote in an update issued Jan. 18 to the Puerto Rico Fiscal & Economic Growth Plan.

—Editor Rosario Fajardo contributed to this story.

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