The chairman of the U.S. House of Representatives committee with jurisdiction over taxation has rejected stealth requests of Puerto Rico’s “Commonwealth” party administration and large manufacturing companies to exempt income that the companies attribute to the territory from a proposed new taxation in a comprehensive reform of the Federal tax code.
This is the second time in less than a year that Ways and Means Committee Chairman Dave Camp (R-MI has turned down their request. He released a full and perfected version of the reform today after releasing a draft earlier.
The ‘commonwealther’/company request would have made the territory the least taxed place in the world for manufacturing.
Camp’s denial contradicts a recent expectation of Governor Alejandro Garcia Padilla’s lead Federal affairs representative. Puerto Rico Federal Affairs Administration Director Juan Hernandez Mayoral said he was “optimistic” of success, terming Federal tax reform efforts a “big opportunity.”
Camp’s initial rejection last summer was followed by a similar rebuff, however, by the then chairman of the Senate committee that handles tax legislation. Senate Finance Committee Chairman Max Baucus said in releasing a tax reform proposal that the “draft does not separately address the taxation of foreign subsidiaries doing business in the U.S. territories.” In other words, income from the operations would be taxed at the same rates that would be applied to profits from other “foreign” subsidiaries.
Baucus has since left Congress but his successor, Ron Wyden (D-OR) has been a strong critic of exempting corporate income from Puerto Rico from the taxes that companies pay on income from other locations as well as a strong critic of the Commonwealth’s territory status.
Tax reform legislation is not widely expected to become law this year. But the Camp and Baucus proposals are expected to influence tax reform efforts in the next Congress. Wyden may be the leading figure in the efforts if Democrats retain a majority of seats in the Senate in this year’s elections.
Camp’s proposal would lower the tax rate for corporate income from 35% to 25%. It would also exempt from taxation 95% of income from outside the States and the District of Columbia — including from U.S. territories such as Puerto Rico, lowering the effective tax rate to 1.25%.
It also, however, includes a provision to prevent companies from avoiding substantial taxation by manufacturing products developed in the States or DC in very low tax jurisdictions such as Puerto Rico. Although Puerto Rico’s corporate income tax rates go up to 39%, the Commonwealth government has signed agreements with manufacturers from outside the territory reducing their income taxes to amounts that generally do not exceed two percent.
The provision would require payment of taxes equal to 25% of the income if products developed in the States are manufactured in low-tax countries or U.S. territories and sold in the States. A 15% tax rate would apply if the products are sold outside of the States. The Federal government would tax the income to the extent that the tax in a foreign country or a U.S. territory was less than 15 or 25%.
Representatives of Governor Garcia and companies manufacturing in the territory unsuccessfully sought exemption from this additional taxation or, at least, a tax rate for Puerto Rico products significantly below the 15 and 25% rates.
Camp’s proposed taxation of income from outside the States and DC would apply annually as income is earned. Currently, companies can avoid Federal taxation by keeping ownership of the income in ‘controlled foreign corporation’ (CFC) subsidiaries organized in territories as well as foreign countries.
Most manufacturing in Puerto Rico is done by CFCs, and most by CFCs organized in foreign tax havens to avoid Commonwealth as well as Federal taxes.
While Camp rejected the Garcia/companies request, his Ways and Means Committee staff views an alternative idea by Puerto Rico’s representative to the Federal government, Pedro Pierluisi (D), as worthy of consideration. The suggestion by the U.S. House member and statehood party president would grant the territory revenue from the new taxation of income from Puerto Rico in cases in which the insular government cannot increase its taxation to 15% or 25% because of legally-binding tax agreements with companies.
Companies and Commonwealth representatives have sought lower Federal tax rates for income from the territory than from other locations since a Federal credit that offset the tax on income attributed to Puerto Rico, U.S. Internal Revenue Code Section 936, was sunset in 1996.
The major stated reason for the repeal was a widely held view in Congress that corporate income from a U.S. territory should not be taxed at a lower rate than income from a State.
A second reason was that companies attributed income to the Commonwealth to avoid taxation that was really due to work in the States, where it would have been taxed. By transferring ‘intangible assets,’ such as patents and brand names for medicines — what Camp now proposes to tax at the 15 and 25% rates, companies were able to avoid much more in Federal tax than they contributed to the territory’s economy. The practice subverted the stated purpose of Section 936: to encourage job-creating investments in the territory, which has perennially suffered from a lack of jobs.
The tax savings were also denying the Federal government billions of dollars in revenue yearly.
Camp’s bill also removes Section 936 from the Internal Revenue Code. Although companies have not been able to take a 936 credit since 2005, the provision remained in the law.
“Commonwealth” party politicians in particular have wanted the lesser taxation for income from Puerto Rico because it could only exist under a territory status and would give them a strong argument against statehood, which has greater support in the territory.
The “Commonwealth” party has also raised a lot of money for its campaigns from people who benefitted from the 936 exemption or would have benefitted from the proposals to replace it.
At least three major efforts to resurrect 936 through similar tax mechanisms have been turned down in Congress despite millions of dollars of lobbying.