The Puerto Rico Treasury Department has spent the last seven months working with a team of local and international experts in tax, fiscal and economic matters to propose an overhaul to the island’s Internal Revenue Code that ultimately should eliminate the “uncertainty” associated with elements of the decades-old statute, agency Chief Melba Acosta told members of the media Thursday.
The comprehensive reform should be ready early in the first quarter of 2015, after going through public hearings at the Legislature and passing through Gov. Alejandro García-Padilla’s desk for a final approval.
In a meeting with business reporters, Acosta explained the work being done by audit, tax and advisory firm KPMG LLP, hired in March to work on a new tax model that incorporates best practices and improves the existing code. The team of 26 professionals from different countries is chaired by former Treasury Secretary Juan Flores-Galarza and includes local Economist Juan Lara, among others.
“We’ve achieved a lot in a short time. From the beginning, we made the importance of this project to Puerto Rico’s economy clear to KPMG,” she said, noting that a state-of-the-art model has already been designed and is being tested. “It must revert the situation Puerto Rico is going through.”
The firm is receiving $4.7 million to complete the analysis and build a tax structure that addresses Puerto Rico’s most pressing needs, to: Produce adequate revenue; distribute the burden of taxation fairly; promote economic growth; increase international competitiveness of products, workers and businesses; minimize interference with private decision-making; and, streamline compliance and administration.
Prior to diving into their analysis, members of the KPMG team met with more than 40 professional organizations, to get a better idea of Puerto Rico’s fiscal situation based on their input, she said.
“They also held individual meetings with relevant government agencies, economists and those affected by Law 154,” she said, referring to the mandate that imposes a special tax on foreign corporations doing business in Puerto Rico.
One of the things the KPMG team is “clear on is that this must be a comprehensive reform,” Acosta said, noting, that initially, the discussion was focused on sales and corporate taxes. However, the conversation has since been expanded to include individual as well as property taxes.
“They’re analyzing the impact that their recommendations could have on different sectors, including individuals based on their salary scales and from the corporate point of view,” Acosta noted.
More than once during the sit-down with reporters, Acosta stressed the need expressed by business sectors of eliminating the “uncertainty” factor associated with the tax code, which puts direct pressure on investments and long-term corporate commitments to Puerto Rico.
For example, she said the corporate sector brought up concerns about what will happen in 2017, when Law 154 collections will shift from the current percentage-based structure to the source of income rule, which could ultimately result in higher or lower taxes.
“The other issue has to do with the IRS notice that gives companies the ability to get a credit for what they pay in Puerto Rico against their federal income taxes,” she said. “However, that’s just a notice, not a ruling, so there is concern over the possibility that the IRS could change its position on that.”
KPMG team members are slated to meet with IRS officials next week to explore options related to the credit, she said.
“What can Puerto Rico do to provide that certainty? Become a place where they want to do business, where they can return to and see as an option,” she said. “Right now, we’re seeing expansions, but we’re not seeing new plants. That’s what we want to see when we talk about international competitiveness.”
Companies under Law 154 contribute $2 billion to Puerto Rico’s general coffers.
‘We need a detailed model’
Meanwhile, Lara explained that the model that has been crafted for Puerto Rico is extremely detailed — something the island has historically lacked.
“We had to design a tool that captures the current tax system and allows for new taxes to be applied, while showing how that can affect or influence other taxes and economic activity,” said Lara, of the Advantage Business Consulting analyst firm.
KPMG designed two economic models, comprising macroeconomic and “Computable General Equilibrium” components that can incorporate simulation and forecasting capacities — which is the core of the proposed structure.
“This model was designed specifically for Puerto Rico and details 90 productive sectors, while incorporating more than 3 million interconnected economic behavioral and accounting equations, and a database containing many millions of data points,” Lara said, noting that the model includes all existing taxes and gives room for introducing new ones down the road and shows the effects they would have.
In the past, when the government carried out tax reform exercises, they designed analysis tools that eventually fell by the wayside due to disuse.
“This model will be used as a permanent analysis tool for public policy at the different agencies,” Lara said. “It’s a tool that Puerto Rico has not had in the past and that we need. This is an investment that goes beyond a tax reform because the idea behind it is that it can help simulate other types of economic policies in the future that don’t necessarily have to be tax-related.”
Under the current contract, KPMG must deliver a final report by the end of next month, which would pave the way for the Legislature to begin its public discussion of what is proposed, Acosta said.
A bill could conceivably be presented in December, for approval early next year, she said.