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Reform Would Also End Puerto Rico Manufacturing Tax Deduction

The U.S. House of Representatives Ways and Means Committee chairman’s Federal tax reform bill would phase out the deduction used by the businesses in the States that manufacture in Puerto Rico directly — versus through the ‘Controlled Foreign Corporations’ (CFCs) that enable companies to avoid Federal income taxation.

The legislation proposed by Chairman Dave Camp (R-MI) would also prevent businesses from using CFCs to avoid income tax.  Most manufacturing in Puerto Rico is done through CFCs.

Companies that manufacture without a CFC pay Federal tax on their territorial income at the regular 35% corporate rate.  For the past several years, they have been able to deduct nine percent of their profits from their taxable income under the Domestic Production Tax Deduction, effectively reducing their tax rate to about 32%.

Camp’s bill would phase out the deduction because it would lower the regular tax rate from 35% to 25%.

The deduction, created in 2004, is ongoing law for income from the States.  It has been  temporary law, however, for income from Puerto Rico.  The last temporary application expired at the end of 2013 but is expected to be extended again.

Although the Senate included income from Puerto Rico in its bill creating the ongoing deduction, insular income was excluded after Resident Commissioner Anibal Acevedo Vila (“Commonwealth” party) opposed inclusion.  He was lobbying for the proposal of Governor Sila Calderon of his party to exempt income from the territory from Federal taxation — a proposal that was rejected twice by the Senate Finance Committee and turned down by Camp’s predecessor as Ways and Means Committee chairman and the U.S. Treasury Department.

In fact, the Senate Finance Committee included income from Puerto Rico in its domestic production deduction bill precisely because it opposed the Puerto Rico tax exemption  proposal.

Resident Commissioner Luis Fortuno (statehood) later got income from Puerto Rico qualified for the deduction but on a temporary basis since the tax committees were already planning to develop tax reform legislation.

The temporary provision for Puerto Rico income expired last December 31st along with about five dozen other temporary provisions of tax law. New Senate Finance Committee Chairman Wyden (D-OR), however, has said that these ‘tax extenders’ will be an early priority.  But Camp has resisted calls to pass tax extenders, reportedly thinking that it will take away some determination and some revenue needed for comprehensive tax reform.

Senate Finance Committee Ranking Minority Member Orrin Hatch (R-UT) and House Ways and Means Republicans have said that not all of the extenders ought to be passed; each should be judged on its individual merits.  There has not been controversy, however, about extending the deduction for income from Puerto Rico as long as the deduction is available for income from the States.

The Congress’s Joint Committee on Taxation estimated in August 2012 that making  income from Puerto Rico eligible would cost the Federal treasury $236 million in 2013 and $122 million in 2014. (Even though the deduction expired in 2013, there are costs this year because of when companies pay their taxes.)

With every dollar of the cost of the deduction representing about $33 in income, the deduction represents a lot of economic activity in Puerto Rico.

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