Budget Omits Tax Benefits for Puerto Rico But Proposes Others

The biggest news for Puerto Rico in President Obama’s Fiscal Year 2014 Budget was his proposal to resolve the fundamental question of the islands’ future status, but tax measures that it did not propose related to the territory — and some that it proposed — are also very noteworthy.

Perhaps the most surprising omissions were two temporary provisions of law specifically aimed at — and important to — Puerto Rico. One allows companies in the States and the District of Columbia to deduct nine percent of their income from production in the territory from their taxable income.

The other transfers to Puerto Rico and the U.S. Virgin Islands $2.75 per proof gallon of the tax on rum from the territories and foreign countries.

The domestic production tax deduction for Puerto Rico income will save companies $358 million in taxes in 2012-3, according to Congress’ Taxation Joint Committee. This represents about $5 billion a year in economic activity in the territory.

The deduction is ongoing law for income from the States and DC. But income from Puerto Rico was not included in the 2004 law after Puerto Rico’s “commonwealth” party representative to the Federal government wanted total exemption from tax for all income from subsidiaries in the territory.

His statehood party successor got the deduction extended in 2006 but on a temporary basis because Republicans wanted to reform the entire Federal tax code.

The deduction can be taken for income companies directly earn in Puerto Rico — not from the ‘controlled foreign corporations’ (CFCs) that the “commonwealth” party representative wanted to have exempted from taxation.

It was most recently continued January 2nd through the end of this year.

The transfer to Puerto Rico and the Virgin Islands of $2.75 per proof gallon of the $13.50 tax on rum from the territories and foreign countries also expires this year.

The transfer will give the insular governments an estimated $222 million during 2012-3. The largest share is expected to go to Puerto Rico because of the amount of its rum production.

But Puerto Rico will give up to 46.5% of what it receives to rum producers to enable them to compete with Virgin Islands companies which are being given up to 47.5%. Before the Virgin Islands agreed to give companies up to 47.5% of the Federal tax transfers, Puerto Rico gave rum producers six percent of the revenue, keeping the rest for public services.

The Obama Administration’s budget only proposed extending a few of the many temporary provisions of tax law.

The Obama budget also did not propose two tax measures recommended by the President’s Task Force on Puerto Rico’s Status. One would extend to low-income workers in Puerto Rico with one child or two the Child Tax Credit payments available to workers with three or more children in the territory and to workers with any number of children in the States and DC. Presidential candidate Obama specifically pledged to try to extend this assistance to low-income workers in the islands with one child or two.

Also recommended by the President’s Puerto Rico Task Force but missing from the budget was including Puerto Rico companies in a proposal to make new grants for advanced energy manufacturing projects, such as equipment that would make energy from renewable resources. The 2009 Recovery Act provided for $2.3 billion in these grants. The Obama Budget proposes another $2.5 billion.

The President’s budget does include Puerto Rico in five tax initiatives. In three, the tax benefits would be provided by the territorial tax system at Federal expense. These are:
• a credit against tax due for new jobs and salary increases in small businesses of 10% of the cost;
• a credit of 20% of the cost of moving a business or line of business from foreign countries to U.S. areas; and a
• a credit of an amount to be determined for investments in communities that have had a major job loss event.

The mechanism of the Federal government giving the territory for tax benefits might also be used for another initiative that would create “Promise Zones” in relatively poor U.S. communities. Companies investing in the zones would get tax credits for wages paid to workers in the zone and other tax benefits.

The Budget would also reduce the cost of tax payment procedures by small producers of distilled spirits such as rum.

The President, additionally, proposed a number of reforms to tax or tighten tax rules related to controlled foreign corporations. Most of the manufacturing in Puerto Rico is done by CFCs. They are likely to strongly oppose these proposals.

Companies in the States established CFCs for their Puerto Rico operations — most in foreign tax havens to avoid Puerto Rico as well as Federal tax — after the tax credits for income attributed to territories and for measurable economic activity in Puerto Rico (known as “Sections 936 and 30A” for their placement in the tax code) were sunset in 1996.

The credits, which ended as of 2006, were repealed so that there would not be a greater tax incentive to manufacture in Puerto Rico than in the States and because a number of companies persisted in abusing the tax credit for income attributed to the islands. The companies shifted ownership of income-producing patents and trademarks developed in the States to their Puerto Rico operations. The maneuver enabled them to avoid much more in tax than their economic contributions to Puerto Rico. The purpose of the credit was to encourage job-creating investments in Puerto Rico.

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