Op-Ed: Impact of federal tax reform bill on Puerto Rico

Written by  //  February 28, 2014  //  Biz Views  //  No comments

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Author Jeffrey L. Farrow is a Consultant on Government Affairs in Washington, DC and Chairman of The Oliver Group Inc. From 1994 to 2001, Farrow was the White House's principal adviser on and coordinator of policy concerning Puerto Rico. (Credit: © Mauricio Pascual)

Author Jeffrey L. Farrow is a Consultant on Government Affairs in Washington, DC and Chairman of The Oliver Group Inc. From 1994 to 2001, Farrow was the White House’s principal adviser on and coordinator of policy concerning Puerto Rico. (Credit: © Mauricio Pascual)

Most manufacturing in Puerto Rico is done by subsidiaries of companies based in the States organized in foreign tax havens to avoid Commonwealth as well as federal taxes. Income of the subsidiaries is not federally taxed unless transferred to the parent company, when it would then owe the 35 percent corporate income tax rate.

Puerto Rico lowers its income tax to not more than 2 percent through agreements with the subsidiaries. It also levies a 4 percent excise tax on parent company purchases of their products. Companies can claim a federal tax credit for payments to the insular government.

U.S. House of Representatives Ways and Means Committee Chairman Camp’s proposal this week to comprehensively reform the federal tax system would lower the federal corporate income tax rate to 25 percent for income from the States and the District of Columbia. It would also lower the effective rate to 1.25 percent on income from outside of the States and DC — U.S. possessions such as Puerto Rico in addition to foreign countries.

It would additionally, however, require taxation of income from manufacturing products developed in the States (intellectual property/intangible assets such as patents and trademarks) in foreign countries or U.S. possessions at the normal tax rate (25 percent) in the case of goods made for the U.S. market and 15 percent in the case of products sold abroad.  The tax would apply to the extent that the income is not taxed in a foreign country or U.S. territory up to 25 percent or 15 percent as appropriate.

Most Puerto Rico products were developed in the states. Some four-fifths of what is made in the islands is sold in the states. So, most goods manufactured in Puerto Rico would have to be taxed at 25 percent of income by the federal or territorial governments.

Gov. García-Padilla and companies lobbied for an exemption from the tax rates on intellectual property or for a lower rate for products made in U.S. territories. Last week, Puerto Rico Federal Affairs Administration Director Juan Eugenio Hernández-Mayoral said he was “optimistic” of success. Camp rejected the idea, as had then Senate Finance Committee Chairman Max Baucus when they made a similar request of his tax reform proposal released last fall.

Puerto Rico Resident Commissioner Pedro Pierluisi has proposed that federal revenue from the new taxation be granted the insular government, similar to the federal grants of taxes on rum made in the territory and foreign countries. The idea would apply to the extent that the insular government cannot tax the income because of existing tax reduction contracts. It would not conflict with tax reform goals, as would the requests of the governor and companies, according to congressional tax committee staff.

Puerto Rico taxation of the income or federal grants would alleviate the territory’s budgetary problems. Some revenue could be used to make Puerto Rico more business friendly (without giving companies back tax revenue). Companies would not have a tax incentive to go elsewhere because no location would offer lower taxation.

Camp’s reform is comprehensive, covering personal as well as business taxation. Another option would be to treat low-income workers in Puerto Rico equally in the refundable portion of the Child Tax Credit, a credit Camp would expand, and extend the refundable portion of the Earned Income Credit which Camp would reform.

These measures would effectively add to wages, to the benefit of workers as well as employers, and put money into Puerto Rico’s economy since the workers would spend the payroll tax refunds. The President’s Task Force on Puerto Rico’s Status has recommended equal eligibility of Puerto Ricans in the refundable Child Credit.

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