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Will Puerto Rico Incentives Code help offset tax slide?

By on June 16, 2018

Editor’s note: This report first appeared in the June 14-20 issue of Caribbean Business. 

The proposed Incentives Code for Puerto Rico raises important questions from the private sector: How does it help mitigate damages caused by President Trump’s tax reform?

Private-sector officials were hoping the proposed Incentives Code would help ease the blow caused by Trump’s tax reform on the island’s economy, which the proposed local tax reform has failed to achieve. Trump’s tax reform treats Puerto Rico as a foreign jurisdiction, which forces companies to pay higher taxes than corporations in the mainland U.S. Local companies must now pay a 12.5 percent tax on intellectual property. Puerto Rico’s proposed tax reform would lower taxes for local companies but not as low as Trump’s tax reform, whose maximum federal tax rate for manufacturing firms is 21 percent, compared to 31 percent in the local legislation.

Certified public accountant Kenneth Rivera said he had hoped the Incentives Code would have helped ease the impact of Trump’s tax reform, but the legislation fails because there appears to be no connection between the local tax reform plan and the incentives, which the Legislature is hastily evaluating to approve before June 25, the last day to pass bills. This week lawmakers are saying they may have to vote on the bill during a special session.

“There is no link between a tax-rate reduction and local investment,” Rivera said. Under Trump’s tax reform, for instance, tax rates are lower to serve as an incentive for companies that purchase U.S. products and equipment, invest more in payroll on the U.S. mainland and in distressed areas. “That kind of link that says I am lowering these rates for you if you invest in this or that…I don’t see it,” he complained. “I am bit disappointed. We were told the bill was going to be some sort of initiative to mitigate the effects of federal tax reform, but we are still in the same boat as we were before,” he added.

The proposed Incentives Code puts all incentives in one bill, dividing them by sectors, such as individual investors, doctors, export, finance, investment, insurance, visitors’ economy, manufacturing, infrastructure, agroindustry, creative industries and entrepreneurs. The code also provides incentives for companies that setup on the island-municipalities of Vieques and Culebra.

Government studies show there are about 76 laws or programs that promote investment through incentives. From that total, 58 promote economic activity and 18 serve social needs. According to the available data, incentives represent a total fiscal cost of more than $7.4 billion, of which 81 percent is considered an opportunity cost.

Roxana Cruz Rivera, assistant secretary of the Puerto Rico Treasury Department, said the proposed code harmonizes existing incentives under a fixed tax rate of 4 percent on earnings made by exempted businesses to allow for better control and to promote savings that will translate into reduced taxes.

Cash benefits and tax credits would total $184 million to $251 million for the next two fiscal years. The savings in the investments will help pave the way for tax reductions for citizens, she said. Manuel Laboy, secretary of the Puerto Rico Economic Development & Commerce Department, said the legislation creates a method through which the government will be able to measure the incentives’ return on investment. “We are not measuring the economic impact but the fiscal cost of the investment,” he told Caribbean Business.

Need to trim incentives

While the federal tax code helped create the conditions for Puerto Rico’s fiscal crisis after Congress repealed the Section 936 tax incentives for subsidiaries of U.S. companies on the island, a trimming of incentives is needed.

Puerto Rico’s statutory corporate income-tax rate is 20 percent and its top marginal income tax for corporations is 39 percent, placing the island on par with U.S. corporate income-tax rates. In practice, few corporations pay anything near the 39 percent rate because Puerto Rico has consistently tried to incentivize economic growth by carving out tax breaks for specific industries. The 2015 Krueger Report, “Puerto Rico–A Way Forward,” said that because of extensive tax credits and exemptions, the island has lost up to $500 million a year in revenue.

The legislation stimulated another change. From now on, incentives will be accounted for in the government’s annual budget, meaning there will be a single fund from which money for incentives will originate. “We are proposing a cap. Part of what we are working on is to cut some of the $600 million in credits and cash grants to finance tax reform,” he said.

The code, which is more than 400 pages, repeals numerous incentives, such as important ones for farming, but consolidates other incentives. Incentives are retained for individual investors and individuals working in sectors in which it is difficult to recruit. It also maintains tax incentives for doctors, who will also be able to have their student loans paid in full by the government if they set up practice in Puerto Rico. Individuals who are scientists or researchers will also be able to obtain tax exemptions. One lawmaker, Rep. Antonio Soto (NPP-Cataño, Guaynabo), believes there should be less focus on individuals and more on companies.

The bill offers incentives for exports of a huge host of services, including public relations, creative industries, computer programs, educational services and communications. Alberto Carrero, lead adviser to the Puerto Rico Fiscal Agency & Financial Advisory Authority, said the measure ensures incentives are granted to both local and foreign companies, which are high performers and main activity focused on exports of goods or services.

Businesses that cater to tourists, such as hotels or theme parks, will also be able to operate with a 4 percent tax rate on earnings. All kinds of manufacturing firms, including those engaged in research & development, can benefit from incentives for up to 15 years. These include companies engaged in added-value activities at island ports as well as at Roosevelt Roads in Ceiba. Companies that engage in infrastructure development and green energy would also qualify for incentives.

While the code eliminates certain incentives for farming, it also provides incentives for planting various crops, dairy, fishing and numerous farming activities. The machinery used will also enjoy certain tax deductions. The legislation would create a program to subsidize up to $5 of the salaries paid to agricultural workers.

The code contains incentives for small businesses and the creation of new businesses. Individuals in the transportation industry will also be able to apply for incentives.

The proposed legislation calls for the creation of programs that would provide cash grants to certain industries. For instance, under the code, the government will give cash grants instead of loans to filmmakers. Laboy said the Film Investment Fund will offer about $1 million in cash grants to eight movies each year over the next two years.

The legislation creates an Economic Development Fund using 10 percent of the money exempted businesses paid in taxes. The Economic Development Fund will be used to subsidize cash grants and to pay for the Invest Puerto Rico program. Besides the film industry, cash grants will subsidize the cruiseship industry and the Green Energy Fund, among others.

All requests for incentives must be approved by Economic Development & Commerce.

More work to do

Juan Colón, operations director of César Castillo Inc., a health, drug and consumer products distributor, says his business ensures manufacturing firms operate in a more efficient and lean manner. “Anything that helps us achieve that, we will support,” he told Caribbean Business about the incentives.

Lourdes de Cárdenas, vice president for the Puerto Rico Manufacturers Association, said that while she had not read the proposed law in its entirety, she was pleased that many incentives enjoyed by manufacturing firms were not repealed. However, she called upon the government to strengthen incentives for research & development.

“Nonetheless, the key message to the government is that we have to keep the incentives that promote research, development and innovation because that is the evolution of Puerto Rican industry,” she said.

Ireland created a strong manufacturing sector that was strengthen through innovation. “It does not have to be innovation in the development of new products but new processes,” she said. “The government has to look toward the future. An incentive is not just one that worked in the past, but we also have to look at what we want as an economic model for the future. There are going to be incentives that remain relevant to our evolution as an island. If this new economic model cuts research & development, we are shooting our own foot,” she added.

Some critics of the legislation noted some incentives, such as those granted to hospitals, were not mentioned in the bill, making it uncertain whether they are being maintained or not. Omar Marrero, head of the Public-Private Partnerships Authority, said incentives for P3s were left untouched.

The legislation, however, would eliminate some incentives enjoyed by farmers. Act 42 of June 2, 1971, or the “Annual Agricultural Workers Bonus Law”; Act 46 of Aug. 5, 1989, or the “Act to Establish the Wage Subsidy Program for Eligible Farmers”; as well as Act 225 of 1995, or the “Puerto Rico Agricultural Tax Incentives Law.”

Additional changes in the bill include the repeal of Act 26-2008, known as the “Law for the Financing Program for Research & Development of Agricultural & Food Technology,” as well as the elimination of Section 1033.12 of Act 1-2011, known as the “Internal Revenue Code for a New Puerto Rico,” to eliminate the 90 percent deduction on agricultural businesses’ net income.

The legislation would also repeal Act 464-2004, known as the “Juvempleo Program Law,” which ensures jobs for young people; and Articles 5, 6 & 7 of Act 73-2014, which would have the effect of eliminating the fund that provides services and therapies to special education students and another fund to promote employment.

The Business Incubator Act, which helps young entrepreneurs creating a business, would also be repealed. The justification to repeal many of the incentive laws is to achieve nearly $300 million in savings that would be used to pay for the tax reform.

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