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Representative Proposes Alternatives for Puerto Rico in Federal Tax Reform Bills

Puerto Rico’s representative to the Federal government, Resident Commissioner Pedro Pierluisi (statehood party/D), late yesterday proposed alternatives for Puerto Rico’s treatment in a reform of the Federal tax system.

The proposals sent to the leaders of the Congress’ committees on tax legislation responded to legislation drafted by the staff of the Senate Finance Committee released by Chairman Max Baucus (D-MT) and by House of Representatives Ways and Means Committee Chairman Dave Camp (R-MI). 

The draft bills would both replace the current system, which permits companies in the States and the District of Columbia to defer paying corporate income taxes by establishing “foreign” subsidiaries in U.S. territories, such as Puerto Rico, as well as  in foreign jurisdictions.  The companies do not have to pay the 35% of income tax until they take legal ownership of the subsidiaries’ earnings.

Both Camp and the Senate Finance staff proposed that the income be taxed immediately.  Camp proposed different options for this but his preferred version would tax income earned from patents and trademarks developed in the States or DC at a new corporate tax rate of 25% if products are sold in the States or DC and a 15% rate for products sold in foreign countries.  Other income would be taxed at only 1.25%. 

Much of the manufacturing done in Puerto Rico would be taxed at 25% since it uses patents and trademarks developed in the States and is sold in the States.

The Senate Finance staff legislation would tax income from goods for sale in the States and DC at a new lower corporate tax rate, which has not been determined but is expected to be about 28%.  Different options were proposed for products for foreign markets, one at 80% of the new rate and the other at 60% of the new rate.

The proposals would also apply to income from Puerto Rico.

Some companies with manufacturing subsidiaries in Puerto Rico and the administration of Governor Alejandro Garcia Padilla (“Commonwealth”) have lobbied for exemptions for Puerto Rico income from the taxes.  Their request would make U.S. territories — really Puerto Rico — the only place in the world that the income would not be taxed equally with income from the States or from foreign countries.

Camp has flatly rejected the idea but told Pierluisi he would work with him to ensure that Puerto Rico is treated fairly as a U.S. area.  The Senate Finance staff also did not agree to the exemption proposal but requested comments regarding the appropriate taxation of the subsidiaries.

The ‘Plan A’ alternative of Puerto Rico’s representative was for the equal treatment of low-income workers in Puerto Rico in the refundable Child Credit program and to extend the refundable Earned Income Credit program to them. 

Puerto Rican workers with three or more children qualify for the refundable Child Credit, which provides payments that supplement their salaries, but Puerto Rican workers with one child or two do not — unlike low-income workers in the States and DC.  The Congress’ Joint Taxation Committee staff estimated in 2006 that equal treatment would inject $180 million a year into Puerto Rico’s economy.

The refundable Earned Income Credit also supplements the salaries of low-income workers.  Congress’ Taxation Committee staff estimated in 2006 that it would provide $520 million a year to low-income Puerto Rican workers.

Pierluisi also asked that Puerto Rico be treated equally in the federal programs for: health care for aged and disabled, Medicare; unemployed poor workers with children, Temporary Assistance for Needy Families; impoverished elderly and disabled individuals, Supplemental Security Income; and health care for low-income individuals, Medicaid.

These programs would invigorate Puerto Rico’s economy with billions of dollars a year.

The Finance Committee has jurisdiction over all of the programs.  The Ways and Means Committee handles legislation concerning all of the programs other than Medicaid.    

Pierluisi, who was the top vote getter in the 2012 Commonwealth elections, supported his primary proposal on three grounds.  One was that past exemptions for corporate income from Puerto Rico had “arguably done more to benefit companies than Puerto Rico.” 

This was the conclusion of studies by the Congress’ Government Accountability Office and others.  The finding, the view of members of Congress that the exemptions were unfair to the States, and U.S. Treasury Department revelations about abuse of the exemptions by companies led to an overwhelming congressional vote to end the exemptions in 1996.  For these reasons, the Senate Finance Committee repeatedly rejected proposals to resurrect the exemptions a decade ago.

Another Pierluisi basis for equal treatment in the programs is that the current “disparate treatment is the principal reason why Puerto Rico’s economy has consistently struggled, regardless of who holds power in Washington or San Juan.” Equal treatment should be provided “to most effectively assist the economic development of Puerto Rico,” the representative explained.

Pierluisi, who also heads the territory’s statehood party, also pointed out that the equality should be extended to “honor’ the “democratic vote” of Puerto Ricans in a plebiscite on political status options held along with the 2012 elections.  Fifty-four percent of the vote was against continuing territory status and 61.2% was for statehood among the alternatives.

Pierluisi’s ‘Plan B’ was for federal revenue from the new taxation to be granted to Puerto Rico for public purposes, such as reducing the high costs of electricity and water, improving substandard public schools, and reducing the territory’s excessive $100 billion public debt. 

The resident commissioner justified this request by noting that the Government of Puerto Rico has entered into individual agreements with the manufacturing subsidiaries it cannot unilaterally change that lower their income taxation to 0-2% of earnings.  The extremely low tax rates contrast with a 39% corporate income tax rate for local companies instituted by the Garcia Administration, an increase from the previous 30% rate. 

Under the Camp and Finance Committee staff proposals, taxes paid to the Government of Puerto Rico or other governments outside of the States and DC could reduce the new Federal taxes on a dollar-for-dollar basis. 

Puerto Rico’s low tax rate commitments to the subsidiaries would prevent it from increasing the rates and benefitting directly from the new Federal tax requirements. 

The Pierluisi grant of Federal taxes request would only apply as long as existing Puerto Rico tax reduction agreements are in effect.

Another possible option for the territory would be to seek to have its excise tax on sales of the subsidiaries’ products count towards the new Federal taxation.  This option has been called into question, however, by the recent announcement by Puerto Rico Treasury Secretary Melba Acosta that the Garcia Administration would propose a replacement for the tax this year.  She has not explained what the replacement would be.   

Garcia, as a member of the Puerto Rico Senate, joined the subsidiaries in opposing the excise tax when it was instituted in 2011.  Last year, however, he got Puerto Rico’s Legislative Assembly to increase the tax.  This was months before Acosta said that he would propose replacing it.     

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