Obama’s proposed cutbacks could set back local CFCs, spur reclassification

Written by  //  September 20, 2011  //  Economy  //  No comments

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President Barack Obama delivers a statement announcing his Plan for Economic Growth and Deficit Reduction, in the Rose Garden of the White House, Monday. (Official White House Photo/Pete Souza)

A proposal in President Barack Obama’s deficit reduction plan unveiled Monday could put a wrench in the joint aspirations of the local government and the private sector to get improved tax conditions for controlled foreign corporations doing business on the island.

As it turns out, in the “President’s Plan for Economic Growth and Deficit Reduction,” the Obama administration takes direct aim at the tax benefits granted to CFCs, through several proposals that, if approved, would increase what they contribute to the federal government’s coffers

About halfway into the lengthy “Living Within Our Means and Investing in the Future” report, the Obama administration proposes an overhaul of the U.S. international tax system — including what companies pay related to offshore operations — that would shave off about $155 billion from the federal deficit over a 10-year period.

Notwithstanding the transfer pricing rules, there is evidence of income shifting offshore, including through transfers of intangible rights to subsidiaries that bear little or no foreign income tax,” the report said. “Under the proposal, if a U.S parent transfers an intangible to a controlled foreign corporation (CFC) in circumstances that demonstrate excessive income shifting from the United States, then an amount equal to the excessive return would be treated as…income.”

Eliminating that benefit given to CFCs alone would represent a $19 billion deficit reduction over a decade. The report mentions several U.S. Internal Revenue Code sections pertaining to international taxes, including IRS Code Sections 482, 367 and 4661, that could potentially be reformed.

Puerto Rico is home to several dozen companies that converted into CFCs after the elimination of tax benefits under the defunct Section 936 of the IRS Code. As CFCs, companies must abide by an income tax system designed to limit artificial tax deferrals by using offshore low taxed entities.

Earlier this year, Microsoft Corp. came under fire for using three jurisdictions where it operates outside the United States — Puerto Rico, Ireland and Singapore — as tax shelters to significantly reduce its federal tax bill, as News is my Business reported.

Reclassifying may be way to go
Ironically, also on Monday, Gov. Luis Fortuño, flanked by Resident Commissioner Pedro Pierluisi and members of the private sector, announced the proposed Puerto Rico Investment Promotion Act, which seeks to increase business investment and create jobs on the island.

Slated to be submitted in Congress this week, PRIPA would authorize — but not require — Puerto Rico corporations that earn at least 50 percent of their income on the island to elect to become domestic U.S. companies, rather than CFCs.

That way, companies would benefit from the same special tax rates given to domestic companies operating stateside. That would be possible under an amended Section 243, which was not mentioned in the presidential report.

According to that section, corporations that have subsidiaries in several states of the nation can benefit from a special tax rate when transferring dividends to their parent companies in the United States.

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