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Ireland Addresses International Tax Reform; Puerto Rico Hasn’t …Yet

Ireland is bowing slightly to international pressure to prevent tax avoidance by companies locating different parts of their businesses in different places — the tax strategy also used by manufacturers that are a big part of Puerto Rico’s economy.

The “Commonwealth” party Government of Puerto Rico, meanwhile, merely says that it “is developing policy responses” to Federal government tax reform initiatives in line with the international consensus against tax avoidance of the type used in Ireland and Puerto Rico by companies based in the States.

Ireland’s Finance Minister last week said that his Government’s proposed 2014 budget would thwart companies not having a residence for income tax purposes anywhere.

Irish law enables avoidance by considering the tax residence of companies to be where the businesses are controlled.  The United States and many other countries regard the primary place of income taxation to be where a business incorporates.

Companies use the Irish law to avoid its 12.5% corporate income tax rate — which is very low compared to the 35% U.S. rate.  In some cases, firms operating in Ireland nominally headquarter corporations in locations with no or almost no income taxation.

Because of this latter practice, U.S. Senators Carl Levin (D-Michigan) and John McCain (R-Arizona) welcomed the Irish plans but said that the plan does not go far enough.  The two senators have also focused on tax avoidance through Puerto Rico.

Companies headquartered in the States delay payment of Federal income tax on profits from Puerto Rico, Ireland, and other places outside of the States  by setting up subsidiary companies (“Controlled Foreign Corporations” or “CFCs”) in Puerto Rico and other locations.  The delay can last as long as the company wants.

In most cases involving Puerto Rico subsidiaries, as in the case of the Irish tax avoidance strategy, companies also establish subsidiaries in other places to own the Puerto Rico companies — which enables them to avoid Puerto Rico income taxes as well.

Although the top income tax rate for businesses in Puerto Rico is 39%, the insular government lowers the rate to not more than two percent for manufacturers from the States.

Last month, the heads of the governments of the world’s 20 largest economies agreed to crack down on the types of tax avoidance strategies used by most companies in the States with manufacturing subsidiaries in Puerto Rico, Ireland, and other tax havens.

President Obama’s Administration and the chairman of the U.S. House of Representatives committee responsible for tax laws have also developed proposed measures to prevent tax avoidance by locating parts of business operations outside of the States.

The common goals of the international and Federal plans include getting businesses to pay tax where income is really earned.

Ireland’s Finance Minister said, “Ireland wants to be part of the solution to this global tax challenge, not part of the problem.”

The international plan to curb “tax base erosion and profit shifting … resulting in very low tax or even double non-taxation” includes specific actions and a timetable.  “Base erosion” is the loss of taxable operations by a jurisdiction due to companies moving the operations elsewhere to avoid taxes.

Actions to be taken within two years zero in on common tax tactics of companies in the States with Puerto Rico manufacturing operations.

One of the actions is to strengthen rules related to CFCs.

Another is to “Develop rules to prevent base erosion and profit shifting by moving intangibles.” ‘Intangibles’ are exclusive formulas, plans, and designs for products and brand names that are responsible for much of the profits generated by medicines, medical devices, computer programs, and electronics — goods that account for much of the manufacturing in Puerto Rico.

The goal is to “ensure profits associated with the transfer and use of intangibles are appropriately allocated in accordance with … value creation.”  The allocation refers to how intangibles are attributed to different locations.  Values for products like most of those manufactured in Puerto Rico are largely created by the development of the formula, plan, design, or name for the product in the States vs. the actual manufacturing in Puerto Rico.

A related action to be taken within one year is to “Re-examine transfer pricing.” This refers to the financial transactions between owning companies and their CFCs for use of the formulas, plans, and brand names through sales or leasing.

The transfer of intangibles was largely responsible for the repeal of a Federal tax exemption that helped lure many of the manufacturers in Puerto Rico to the territory.

U.S. Internal Revenue Code Section 936 was enacted into law to encourage companies to make job-creating investments in Puerto Rico.  The law provided a tax credit equal to the income tax that would be due on profits attributed to operations in the territory.

But companies abused the law by attributing to Puerto Rico income that should have been allocated to operations in the States, where products were developed.  This was done by paper transfers of “intangibles.”

The net result was much greater benefits for companies than to Puerto Rico’s economy.  Some companies saved hundreds of thousands of dollars each year for each job.

The law was repealed in 1996, with all benefits for companies expiring at the end of 2005.

Companies avoided the repeal’s intended Federal taxation, however, by exploiting a loophole that enabled them to have CFCs and defer Federal taxation in Puerto Rico even though it is a U.S. territory, treated equally with the States in most Federal programs.

“Commonwealth” party administrations and companies have tried to get the Federal government to recreate the tax exemption.  Most Federal officials have steadfastly refused, with the reasons for the repeal of 936 being among the reasons for their rejection.

Chairman Dave Camp of the U.S. House tax committee, Ways and Means, recently turned down the latest proposal, which would have exempted Puerto Rico from his draft legislation for taxing profits due to intangibles of companies based in the States and their subsidiaries wherever located.

The proposal by companies was made in response to Camp’s draft plan to comprehensively reform Federal income taxation. The chairman of the Senate committee handling tax laws, Finance, is also drafting a tax reform proposal in close coordination with Camp.  And Finance Committee Chairman Max Baucus (D-Montana) recently noted that tax reform objectives of both chairmen are similar to those of the Obama Administration.



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