Senior US Senator: Close Puerto Rico Tax Loophole

A senior U.S. senator identified closing the tax loophole that enabled Microsoft to avoid $4.5 billion in Federal income taxes 2009-11 by attributing up to 47% of its sales in the western hemisphere to its Puerto Rico subsidiary as one of his  top priorities as he approaches retirement.

Sen. Carl Levin (D-Michigan), Chairman of the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government, targeted the loopholes in a C-Span interview broadcast late yesterday.

Levin added that closing the loopholes will “probably be left undone” when he leaves the Senate January 6^th with the seating of the next Congress.

The senior Republican Party member of the Subcommittee, John McCain (Arizona), has worked collaboratively with Levin on the issue. The 2008 Republican presidential nominee is expected to succeed Levin in both chairmanships in the next Congress.

Senator Levin, who is 80, is retiring. His brother Rep. Sander Levin (D-MI), 83, will remain in the U.S. House of Representatives, where he is the top Democrat on the tax-writing Ways and Means Committee.

Senator Levin said that the “loopholes,” which enable Microsoft to avoid U.S. taxation through Puerto Rico and Ireland and Apple to avoid Federal taxes trough Ireland, are “gimmicks … which don’t serve any justified economic purpose.”

He explained that the loopholes enable manufacturing companies in the States “to shift their revenue … profits and IP [intellectual property, or patents] to themselves, to their own shell corporations in tax havens to avoid paying taxes.”

Prevents Important Spending

The senator said that this costs the Federal government revenue it needs “to avoid another round of sequestration, which is this absolutely mindless way to cut the budget … an automatic cookie-cutter approach.”

He went on to say that most in Congress “really want to end sequestration from whatever perspective, whether it is domestic programs, like education, roads, healthcare, or whether from the national security perspective.

“So, we need to close the unjustified tax loopholes that don’t serve any economic purpose in part to use that revenue … in these important areas, such as national security, education, and so forth.”

Dozens of companies use Puerto Rico for the loopholes and tax avoidance the way that Microsoft does, a topic that was the subject of a Congressional hearing conducted by Senator Levin in 2012.

The current sequestration was enacted into law through a budget compromise between President Obama and congressional Republicans in 2011, and began to take effect last year. It provides for most Federal programs to have spending cut by one of a few percentages without regard to reason. The totals of reductions in national security programs on one hand and domestic programs on the other are in equal dollar amounts.

The process was considered by both sides to be so bad that it would force both to compromise on changes in tax and spending policies. It has not really worked, however, and national security leaders like Levin have been particularly concerned as national security programs are cut by a larger percentage than domestic programs.

The Loopholes

The basic tax loophole that disturbs Levin and tax policymakers ranging from Obama to House Ways and Means Committee Chairman Dave Camp (R-Michigan) enables U.S. companies to set up corporations outside of the U.S., transfer patents and trademarks (brand names) developed in the U.S. that are responsible for most of the profits from products to the subsidiaries, and not pay taxes on income of the operations unless the profits are actually transferred to the parent companies.

The Puerto Rico loophole does not include the territory in the definition of the U.S., although Puerto Rico is fully a U.S. territory. So, companies in the States can set up tax avoiding “Controlled Foreign Corporations” in Puerto Rico that receive most of the benefits of being in the U.S. without the tax responsibility borne by business in the U.S.

Loopholes Unintended

Companies began major exploitation of the loophole after the Federal government enacted a law in 1996 ending by 2006 a tax elimination (or, after 1993, a tax reduction) incentive for companies based in the States to operate in Puerto Rico.

One major reason that Congress overwhelmingly voted to end Federal Internal Revenue Code Section 936 was because it was being abused in the same way that companies are now taking unintended advantage of the Puerto Rico tax loopholes that Levin, Obama, Camp, and Senate Finance Committee Chairman Ron Wyden (D-Oregon) want to end: shifting ownership of profit-generating patents and trademarks to territorial operations to avoid taxes.

In the cases of many companies, the tax avoidance was much larger than the economic benefits of their operations to Puerto Rico. Sec. 936 was enacted to encourage companies in the States to make job-creating investments in the territory.

According to the Joint Committee on Taxation, Congress also decided that there should not be a greater tax incentive to do business in the territory than in a State.

Retards Economic & Political Growth

The tax loopholes, like Sec. 936 before, have left Puerto Rico with an underdeveloped economy, one that has underperformed the economies of the States for four decades and one that has been negative for all but one of the last nine years.

Puerto Rico’s “commonwealth” party uses the relatively small economic benefits of the loopholes to argue against equality for Puerto Rico and Puerto Ricans in the U.S.: statehood. It used the relatively small economic benefits to the territory of Sec. 936 to argue against equal treatment of Puerto Rico in the nation.

A majority of Puerto Ricans have voted against territory status, however, and a more than three-fifths majority has voted for statehood among the alternatives to territory status.

The “commonwealth” party has made several proposals for an unprecedented “commonwealth status” but all have been rejected by the Federal government as impossible for constitutional and other reasons.